BOND REPORT: Saudi Oil Attack Shows Bond Traders Are Worrying More About Growth Than Inflation
17 September 2019 - 2:22AM
Dow Jones News
By Sunny Oh
Bond yields tumbled even as inflation expectations rose
Investors just received another reminder that global
geopolitical jitters -- and the threat to economic growth --
remains the main driver for the U.S. Treasury market and
yields.
The drone attack on Saudi Arabian oil production facilities over
the weekend put a halt to one of the steepest bond market selloffs
in several years as panic-stricken investors flocked back to the
safety of government paper on Monday. Despite markets pricing in
higher inflation expectations from skyrocketing crude prices, the
accompanying drop in Treasury yields underlines how demand for
havens have overshadowed fears of price pressures. Yields and bond
prices move in opposite directions.
"It's obvious that the broader growth implications far outweigh
any near-term inflationary impulse," said Ian Lyngen, head of U.S.
rates strategy at BMO Capital Markets, in a note.
The 10-year Treasury note yield fell 5.1 basis points to 1.848%
on Monday, after logging its biggest weekly rise since 2013 last
week.
See: Why the Saudi oil attack is a 'big deal' that could be a
'game-changer' in stock markets and crude prices
(http://www.marketwatch.com/story/why-the-saudi-oil-attack-is-a-big-deal-that-could-be-a-game-changer-in-stock-markets-and-crude-prices-2019-09-15)
Monday's bond-market action goes against how values for
fixed-income assets usually interact with crude markets. Higher oil
prices tend to deliver a knock-on rise in government bond yields,
and lower debt prices, because they stoke inflation, the bogeyman
of debtholders who worry that its corrosive effects can erode a
bond's fixed-interest payments.
West Texas Intermediate crude for October delivery, the U.S.
benchmark contract, surged 11.6%, or $6.37, at $61.22 a barrel.
As a result, inflation expectations have risen. The 10-year
breakeven inflation rate jumped nearly 5 basis points to 1.78% on
Monday, from a nearly three-year low of 1.51% set on Sept. 3, data
from Tradeweb show.
The breakeven rate represents the difference between the nominal
bond yield and the inflation-adjusted yield, in other words, it
reflects bond investors' expectation for the average rate of
inflation over a number of years.
Lyngen say it's important to pay attention to the underlying
cause of higher crude values.
He said the double-digit percentage rally in the U.S. oil
benchmark was driven by fears of tightening supply as opposed to a
broader increase in demand for commodities from faster economic
growth. In addition, higher energy costs have historically led to
elevated recession concerns, though that relationship has come in
doubt as the U.S. has become a larger crude producer.
In that backdrop, the Federal Reserve may not see the rise in
market-based inflation expectations as a reason to hold back on
further easing, which should deliver a boost to government
bonds.
"The attacks only reinforce our expectations for the Fed to cut
rates a quarter-point on Wednesday and then again in October," he
said.
Read: Here's what happened to the global economy the last eight
times oil prices have doubled
(http://www.marketwatch.com/story/heres-what-happened-to-the-global-economy-the-last-eight-times-oil-prices-have-doubled-2019-09-16)
Still some expect prospects of stronger price pressures to
ultimately contain a further surge in government bond prices,
despite how Treasurys gained value on Monday.
"As long as breakevens are rising it will be very hard for
[long-dated bonds] to rally much further in North America," wrote
Ian Pollick, head of North American rates strategy at CIBC Capital
Markets.
(END) Dow Jones Newswires
September 16, 2019 12:07 ET (16:07 GMT)
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