Iran war fuels bond-market selloff, as inflation fears put future Fed rate cuts in doubt

By Joy Wiltermuth

Uncertainty over the Iran war and oil prices is pushing up bond yields

Global oil futures briefly touched $120 a barrel on Wednesday.

The oil shock and elevated inflation were top worries for investors in the bond market Wednesday, as Federal Reserve Chair Jerome Powell concluded his final press conference at the helm of the U.S. central bank.

The week will see a grand total of 10 global central banks hold meetings, with the expectation being that the lack of crude-oil and petroleum supplies flowing from the Persian Gulf will keep most on hold and reluctant to cut interest rates anytime soon.

Nine weeks into the Iran war, investors in the U.S. stock market still seem optimistic that President Donald Trump will find an off-ramp that eventually brings down oil prices, helps put a lid on inflation and prevents the economy from veering into a ditch.

That notion helped the S&P 500 SPX and Nasdaq Composite Index COMP push deeper into record territory in April, before the rally paused earlier this week.

Yet the jump in crude prices over the past week had Brent oil futures (BRNM26) briefly touch $120 a barrel Wednesday, before settling below that threshold. Brent futures overall were above levels seen since the April 8 cease-fire agreement between the U.S. and Iran - and this has the Treasury market on edge.

"The bond market is taking a big signal from the oil market, and it's not sending a good signal," said Stephen Douglass, chief economist at fixed-income specialist NISA Investment Advisors.

The 10-year Treasury yield BX:TMUBMUSD10Y was at 4.415% on Wednesday, its second-highest level of the year, according to Dow Jones Market Data. That has kept the costs of auto loans and home mortgages elevated, hurting affordability. Bond prices move inversely with yields, falling as yields climb.

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What's more, tariff pressures and the war have added to inflation that's been moving higher, not lower - putting the annual rate closer to 3%, versus the Fed's 2% target.

"Inflation is a concern for bond investors," said Andrew Clinton, CEO and founder of Clinton Investment Management. For fixed-income assets, he said, it's the "bogeyman that haunts us." If oil prices remain well over $100 a barrel for too long, it can hurt demand, cut into consumer spending and act as a drag on the economy.

Dire predictions from oil analysts and the tone in the stock market have been "night and day," Douglass at NISA said - adding that a lot is riding on the notion that the war is on a path to being resolved, or at least continuing to de-escalate. "But at some point, we need to see the oil start moving."

The Fed didn't cut rates on Wednesday, as expected, but there were signs that its rate-cutting cycle may be coming to a close. Oil analysts have warned of a ticking time bomb as crude supplies are depleted, unless there's a resolution that reopens the Strait of Hormuz and allows the free flow of tankers and other shipping traffic to resume.

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Scott Pike, senior portfolio manager at Income Research + Management, said bond investors remain cautious given "there is still a significant amount of uncertainty around the current conflict," with clients watching oil prices and asking if inflation is going to be a problem for the bonds they own.

Yet while they're talking and asking questions, clients haven't been making a notable shift in allocating toward things like Treasury inflation-protected securities, which are designed to safeguard against rising price pressures.

"We are not seeing that sort of flow," Pike said. "We've had periods in the past when concerns increase, and everybody wants to talk about it. But they aren't ready to reallocate based on that."

-Joy Wiltermuth

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