Global stock markets experienced a downturn on Monday as a bond sell-off intensified and oil prices climbed. This market reaction followed President Donald Trump's rejection of Iran's latest offer to reopen the Strait of Hormuz, a critical waterway for global energy supply. The stalemate in US-Iranian talks renewed inflation concerns, particularly given that Brent oil prices rose nearly 2% to $106.31 a barrel and Brent futures were up 4% to $108.5 a barrel, bringing monthly gains to 20%. US crude also rose 3.5% to $95.60 a barrel. The increase in oil prices is putting pressure on the Federal Reserve to continue hiking interest rates.
The bond market reacted significantly, with long-term US bond yields reaching their highest levels since 2004 for 30-year Treasuries and 2007 for 10-year Treasuries. The yield on benchmark US 10-year notes was up 8.25 basis points at 5.26%, and the 30-year bond yield was up 7.4 basis points at 5.576%. Rate-sensitive US two-year bond yields rose five basis points to 4.90%, contributing to a 56 basis point increase in September, their largest monthly rise since February 2023. This rapid increase in short-term yields has led to a flattening of the yield curve, with the discount of 2-year yields to 10-year yields narrowing to around 30-31 basis points from approximately 40 basis points a month ago.
Analysts are attributing the market's "higher for longer" narrative for interest rates to the hawkish messaging from the Federal Reserve and sustained high oil prices. Damien McColough, head of fixed income research at Westpac Banking Corp, noted that the ongoing hawkish Fed messaging and oil above $100 are pivotal to the bearish impetus. Prashant Newnaha, senior Asia-Pacific rates strategist at TD Securities, stated that President Trump's rejection of Iran's offer is driving renewed oil price increases and weighing on US Treasuries. The market now implies a roughly 70% chance that the Fed will hike rates for a second straight meeting in October, with about 90 basis points of tightening priced out to late next year.
Despite the rising yields and oil prices, US growth and corporate earnings have been robust, allowing Wall Street and Main Street to largely absorb these pressures so far. However, the bond market's current state, marked by a flattening yield curve, is nearing a point that could signal a shift towards the risk of the US economy stalling out. While Treasury Secretary Scott Bessent has urged the Fed to consider that productivity gains from AI and deregulation could help keep inflation in check, the immediate focus remains on geopolitical developments and upcoming economic data, including PCE, ISM, and payrolls, later in the week.
