If crude oil falls, won't interest rates? Three pressures driving the 10-year US Treasury yield to 5.27%

The yield on the 10-year US Treasury note has risen to 5.27%, and Brent crude oil has also climbed to around $106.

Looking at this alone,

one might be tempted to think, “Crude oil rose → inflation is a concern → interest rates rose.”

However, this rise in interest rates cannot be explained by that alone.

What is more concerning is the possibility that long-term interest rates will remain high even if crude oil prices stabilize.

Breaking down what is happening in the bond market, there are three major pressures pushing up long-term interest rates.

1. High crude oil prices and inflation

2. Rise in real interest rates
3. Supply and demand issues regarding who will buy the massive amount of government bonds
By separating these three, it becomes much easier to see whether “this rise in interest rates is temporary.”

First, why do interest rates rise when crude oil rises?

As of September 29, Brent crude oil is around $106 per barrel.

If energy prices rise, they may push up prices through gasoline and transportation costs.

If that happens, it becomes difficult for the Fed to say,

“Inflation has settled down, so it’s okay to lower interest rates.”

In fact, the probability of a Fed rate hike in October priced in by the market had risen to about 72%.

The flow is simple.

High crude oil prices

→ Inflation concerns

→ Fed finds it hard to lower interest rates
→ Long-term interest rates rise
This much is easy to understand.
The problem is what comes next.

In fact, “inflation expectations” have hardly risen.

The 10-year US Treasury yield rose from

4.79% on September 1

↓

to 5.18% on September 24.
This is an increase of about 0.39 percentage points.
However, the 10-year breakeven inflation rate over the same period

fell slightly from

2.35%

↓

to 2.33%.
The breakeven inflation rate is a benchmark for looking at the average future inflation rate expected by the market.
In other words,

even though long-term interest rates have risen significantly, the market’s long-term inflation expectations have hardly risen at all.

This is the key point this time.

So, what is pushing up interest rates?

Long-term interest rates can be thought of, in a very simplified way, as:

Real interest rates + Expected inflation.

Calculating with this approach:

September 1

4.79% – 2.35% = approx. 2.44%

September 24

5.18% – 2.33% = approx. 2.85%

This means the real portion alone has risen by about 0.41 percentage points.
In other words, it is difficult to explain this rise in interest rates solely by “worrying about inflation due to high crude oil prices.”

Investors may be demanding higher interest rates for reasons other than inflation.
Another problem: “Who will buy all these government bonds?”

This part is a bit understated, but it is quite important.

When the government issues a large amount of government bonds, someone must buy them.

If enough buyers do not gather at the current yield,

the result is, “I will buy if the interest rate is a little higher.”

In other words, bond prices fall and yields rise.

It was reported that a weak US Treasury auction on September 28 shook the bond market.

This does not mean that “no one is buying US Treasury bonds anymore.”

Instead, it means that there are times when higher yields than before are needed to get the market to absorb the large volume of government bonds being issued.

Therefore, “if crude oil falls, we can rest easy” is not necessarily true.

Summarizing the three points so far:

① Crude oil/Inflation: Likely to weaken if crude oil falls.

② Real interest rates: Influenced by the economy, monetary policy, and capital demand.

③ Government bond supply and demand: Related to the volume of bond issuance, investor demand, and views on fiscal policy.

If crude oil prices fall below $100, the pressure from ① will likely weaken.

But if ② and ③ remain,

it is entirely possible that long-term interest rates will not fall as much as expected even if crude oil falls.

It also matters to those who own stocks.

You might think, “This is about bonds, so it doesn’t really concern me.”

But it also matters to those who own the S&P 500, total world stock funds, and especially growth stocks.

When long-term interest rates rise, the present value of future profits generated by companies tends to be valued lower.

Especially for companies like those in AI, where the stock price includes a lot of expectation that “they should generate large profits in the future,” they are more susceptible to the impact of rising interest rates.

However,

it is not a simple story that “if interest rates exceed 5%, stocks will definitely fall.”

If corporate profit growth is strong enough, it can sometimes overcome the headwind of high interest rates.

Therefore, what you should look at is

not just “what the interest rate percentage is.”

You need to look at whether corporate profit growth can exceed the burden caused by rising interest rates.

You need to look at these as a set.

Four numbers to check from now on.

If you want to see how the market will move when crude oil falls in the future, you should look at the following four things together:

1. 10-year US Treasury yield: First, the long-term interest rate itself.

2. 10-year breakeven inflation rate: To what extent does the market expect long-term inflation?

3. Real interest rates: Are interest rates high even excluding inflation?

4. Demand for US Treasury auctions: At what yield can the market absorb a large amount of government bonds?

Rather than just following crude oil, looking at these four together makes it easier to understand the current market.

“After crude oil falls” is actually more important.

Right now, the figure of $106 for crude oil is eye-catching.

However, what is truly important for investors might be what comes next.

Crude oil prices have fallen.

Yet, the 10-year US Treasury yield remains in the 5% range.

If that happens,

it cannot be explained by a “temporary energy shock” alone.

It will become necessary to consider more structural problems such as real interest rates and government bond supply and demand.

Conversely,

if crude oil falls, economic indicators weaken, rate hike expectations recede, and government bond auctions improve.

If all those things overlap, the conditions for a significant drop in long-term interest rates will be met.

When looking at the current market, **”how interest rates move after crude oil falls” is more important than the crude oil price itself.**

This is because it will be a clue to distinguish whether the current high interest rates are temporary or if we are in a phase where “high cost of capital” will continue for a long time.

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For those who want to read more in detail:

In this article, I have narrowed down and organized the three points of “crude oil, real interest rates, and government bond supply and demand” for note.

The original beiyomi article delves deeper into the background of the global bond market slump, the connections between various data, comparisons using charts, and the impact on the stock market.

▶ Original article

“10-year US Treasury 5.27%, crude oil $106. ‘Three pressures’ driving the global bond market slump”

If you want to check including data and charts, please take a look here as well.

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Main reference materials: U.S. Treasury, Federal Reserve / FRED, Reuters, U.S. EIA

*This article is for informational purposes only and does not recommend the buying or selling of any specific financial products.