By Karishma Vanjani
Oil prices and U.S. Treasury yields have been moving practically in lockstep this month. So that should mean that when the Iran war resolves and energy prices ease, yields should also decline, right?
Think again.
That correlation between energy prices and bond yields has drawn a lot of attention in the market, as the two moved in tandem around the start of this month. By mid-May, a bond market selloff had taken shape, with 30-year Treasury yields surging to their highest level since 2007. (When bond yields go up, bond prices go down.) The surge in crude prices took the blame.
But a look under the surface tells a much bigger story about what's driving the climb in U.S. government debt yields, and oil actually has very little to do with it. That means investors can't count on an end to the Iran war and oil volatility to bring Treasury yields down.
To understand this, take a look at the breakdown of Treasury yields, which is the underlying, or real, yield plus inflation expectations. For instance, the real yield on the 10-year was 2.09% on Wednesday. Add to that inflation expectation of 2.39% for the next 10 years, and you have the bond's overall, or nominal, yield of 4.48%.
Different factors move those two yield components. Real yields rise on expectations of a strong economy, high government debt issuance, or a Federal Reserve that is expected to raise interest rates, among other factors. Inflation expectations, meanwhile, are influenced by energy prices and other price pressures.
Since the Iran war started, the 10-year yield has risen by 0.52 percentage points. But increase in inflation expectations made up only a quarter of that gain, with the remaining 0.37-percentage-point rise coming from real yields.
That means while oil prices and yields have moved in tandem lately, bets on higher energy-driven inflation aren't the main driver. Real yields, and the factors pushing them higher, are the true culprits behind higher 10-year yields.
In fact, multiple data points show that inflation expectations have been stable. A gauge that measures average expected inflation rate over a five-year period beginning exactly five years from today has barely budged, up just 0.14% points since the war started.
"This suggests that a reversal of the move [in yields] will likely require more than just an end to the ongoing supply disruption in the Middle East," wrote BMO Capital Markets strategists Ian Lyngen and team on Thursday.
In other words, a decline in oil prices won't bring Treasury yields down much, because there was never a surge in long-term inflation expectations to begin with. In addition, the oil-yield correlation has gradually weakened over the course of this month.
There are ways to play this dynamic, though.
For investors who see no end in sight to the Iran war and expect oil prices to rise, can play the correlation by betting against a 2-year Treasury bond, or short the bond. It has "greater sensitivity to higher vs lower oil," Bank of America writes.
The optimists, looking ahead to a peace deal, can expect the Treasury market to refocus on other drivers once the war ends, like the Fed. Kevin Warsh's first meeting as chairman of the central bank is scheduled for June 16 and 17.
One concern is that, under Warsh, the Fed could raise its target for inflation from 2% and the other concern is that the central bank starts to wind down its still-sizable holdings of Treasuries, which would increase market supply of such debt and push prices lower (and yields higher).
"Either one of these could cause a substantial sell off in the bond market" Will Denyer, lead analyst on the U.S. economy at Gavekal Research said in an interview. "However, the changes [on the balance sheet] are likely to be executed in a way that is intended to provide the least disruption to the bond market as possible."
Write to Karishma Vanjani at karishma.vanjani@dowjones.com.
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 29, 2026 02:30 ET (06:30 GMT)
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