The war in Iran has stoked inflation fears, sending US Treasury bond yields higher, but don’t expect the trend to reverse once the war is over.
Two of Wall Street’s top economists warned that the ongoing Iran war isn’t the only force driving yields higher. Investors should expect steadily rising bond yields even after the conflict in the Middle East resolves, according to Mark Zandi, Moody’s Analytics chief economist, and Torsten Sløk, Apollo Global Management’s top economist.
The 10-year yield hovered just under 4.5% on Tuesday, a key level flagged as a threat to stocks by top forecasters like Morgan Stanley CIO Michael Wilson. The 30-year Treasury bond yield was above 5%.
While yields have edged lower recently on hopes for the war to soon be over, Mark Zandi noted that the conflict is not the only force sending yields higher.
“Treasury yields have jumped in big part due to the Iran War and the resulting increase in inflation expectations, but also to the ballooning federal budget deficit and surge in Treasury securities issuance necessary to finance it,” he wrote.
The economist flagged an uptick in Treasury issuance, noting that monthly issuance has reached almost 10% of GDP.
Mark Zandi
The issue that Zandi flicks at is a classic supply and demand dilemma, as treasury supply has risen amid at a time when buyers have become fewer.
“The Fed is no longer aggressively expanding its Treasury holdings, banks have been more circumspect buyers since their bond portfolios were turned upside down when the Fed jacked up interest rates a few years ago, and big global investors such as the Japanese and Chinese are less avid buyers for obvious reasons,” he wrote, adding, “That leaves highly leveraged, capricious hedge funds as the dominant new buyers.”
The economist said, “Interest rates go up, and down, and all around…but cutting through the volatility, the direction of travel for rates is higher.”
Apollo’s Torsten Sløk called out inflation staying higher for longer, a byproduct of the ongoing conflict in the Middle East, as placing upward pressure on the front end of rates.
Hyperscaler issuance fueling upward pressure on the belly of the curve, while heightened Treasury supply and less Fed demand are sending long end-rates higher.
FRB, Haver Analytics, Apollo Chief Economist
“The bottom line is that three distinct forces are pushing rates higher across the curve, and investors should position for a persistently higher rate environment,” Sløk said.
