The bond market is flashing a warning, energy geopolitics expert warns
Don’t look now, but the pain from higher energy prices may be about to bite Americans twice.
With no end to the war in Iran on the horizon and oil prices stuck above $100 a barrel, bond traders are concerned about inflation in recent days as long-term public debt in the United States and advanced economies have been sold off. This has the effect of increasing bond yields, including the benchmark 10-year Treasury bondIt rose nearly 24 basis points last week and closed around 4.6% on Friday.
The 10-year Treasury yield affects the cost of mortgages, vehicle loans, credit card interest and other consumer debts. When it rises, consumers feel the pinch. The market determines the interest rate, not the Central Bank.
To unpack what’s happening at the intersection of geopolitics, energy and global debt, CNBC reached out to: Daleep Singhis a vice president and chief global economist at asset manager PGIM. Singh has seen global energy conflicts up close: deputy national security advisor Under President Joe Biden, he has designed the administration’s economic efforts to cut off Russia’s oil revenue. Earlier in his career, Singh managed the markets desk at the Federal Reserve Bank of New York; This was a delicate position that looked directly into the bowels of the global financial system.
Singh may have been appointed by a Democrat, but he’s not speaking the party line. He began his speech by praising conservative economist Kevin Warsh, who was appointed by President Donald Trump and confirmed Wednesday by the Senate to lead the Federal Reserve.
The transcript of Singh’s speech has been edited for length and clarity. He spoke via Zoom on Friday.
Q: How do you think Kevin Warsh will do as Fed chairman?
Daleep Singh: I’m optimistic about Kevin Warsh. His intellectual work focused on how to maintain the Fed’s most important asset, its credibility. This could not be more important at a time when the central bank is under political attack. I think he will be thoughtful and prudent in evaluating the trade-offs necessary to preserve the independence of monetary policy, perhaps to the detriment of other responsibilities the Fed once had.
Having a battle-tested Fed chairman is also crucial. Warsh went through the global financial crisis. [Warsh was a Fed governor from 2006 to 2011.] The Fed was credited by almost everyone with being the eyes and ears on Wall Street and how that was going in terms of transmitting the response to the real economy.
People who reflexively dismiss him as partisan are missing a lot of what he brings to the table in terms of working across the aisle.
That said, look, I don’t think the Fed should cut rates right now. We will soon find out how much room he has to do the right thing.
Question: There is a perception that Warsh will try to persuade the Fed to lower rates and that it will be laughed at. Then Trump will explode at him. Are people underestimated? Ability to influence Trump?
Singh: The deepest question is whether it is in President Trump’s political interest to push the Fed to expand. The market is currently pricing in the possibility that the Fed will raise interest rates rather than expand this year, and for good reason.
We have seen a structural break in the economy. These supply-side shocks are not independent of each other and are not malevolent in their impact on the global economy. These are interrelated and overlapping.
Just look at the last five years, from Covid to Ukraine, from a step change in tariffs to immigration restrictions and now Iran, we have had nothing but supply shocks. These overlapping supply-side shocks suggest to me that we will be in a structurally higher inflation environment.
Q: The 10-year Treasury yield hit 4.6% at one point on Friday, the highest level in nearly a year. Yield England, Japanand increasing elsewhere. What is your diagnosis of the global bond market?
Singh: It’s a byproduct of these forces that we’ve been discussing. If we are to live in such a world fiscal deficit If it continues to rise indefinitely, there really isn’t any political will to do anything about it, and if there’s a central bank, at least in the US, that is extremely hesitant to, say, raise interest rates, then it seems logical that the yield curve would steepen. Long-term yields will continue to rise because buyers need more compensation for the financial and inflation risk they are now taking on.
Savvy investors will understand that this is a multi-stage process, and the U.S. government will also decide how to respond to a sharp and sustained rise in long-term yields.
If it continues like this, let’s call it Treasury yield [on the 10-year note] If it gets to 5% or more, it won’t be long before the Treasury Secretary says, “Listen, I’ve got a toolbox and I’m not afraid to use it.” The treasury secretary could shorten the weighted average maturity of our debt issuance, use the buyback tool more aggressively, and potentially take the piss out of the Fed and the market and say we might need to buy long-dated bonds to bring them in line with long-term fundamentals.
In other words, this is financial pressure [when the government artificially holds interest rates down, making debt more manageable at the cost of harming savers, among other risks].
I think this is the endgame for the bond market because bond yields above 5% are not sustainable for a variety of reasons.
Question: How big is the risk that the 10-year Treasury yield will reach 5% in the next few months?
-Singh: I think this is likely. We are currently on the verge of a bond trade. Implemented in the UK These moves often come to life on their own and do not correct themselves until there is a policy response.
This is an extremely knowledgeable U.S. government that understands bond market dynamics and knows how to stop the rise in yields. Personally, I don’t think bond trading will survive for very long.
Question: Let’s return to Iran. Can you put forward your thoughts on what’s going on there?
Singh: I think both sides have no control over escalating tensions, but neither the US nor Iran are fully aware of this fact.
Both the political and economic costs of a ground attack that would lead to regime change in Iran are too high for President Trump; both because of losses in the field and because Iran will undoubtedly further weaponize its asymmetric advantages in the Strait of Hormuz and the Red Sea.
For Iran, I also think that it is aware that if it overplays its hand, it could accelerate what it is trying to prevent, which is the US sending ground troops.
We want both sides to accept the fact that neither side can suppress the other, and that’s why we’re in this stalemate.
A deal needs to be guaranteed by a trusted third party. There is currently no trust between the US and Tehran because bombs fall every time they sit down to negotiate. This is where China comes in, and I’d love to hear more details about what’s been said and accepted in Beijing [during Trump’s summit with Xi Jinping].
We’re probably a month or two away from that kind of deal happening, because if it takes any longer, this becomes an unsustainable conflict for the White House.
Q: Still means another month or two a lot of economic pain.
-Singh: I was just in Texas. I heard directly from him the most that could be expected. Permian Basinfor example, in terms of additional production, it is around 250,000 barrels per day. This is only a small part of the gap in the Strait of Hormuz. [The oil market may be missing as much as 100 million barrels a week, according to some estimates.]
The situation is getting really dire. I think we have a persistent risk premium Brent oiland will be in the range of $80 to $100 per barrel for the foreseeable future.
Q: What do you think about how long the Iranians can withstand the economic pressure they are currently under due to the blockade?
Singh: My first-hand experience is that in terms of applying maximum economic pressure on an autocratic regime, these regimes tend to have a much longer runway than a democratic one, as Western leaders assume, because necessity is the mother of invention. They will develop workarounds to receive payments in exchange arrangements, crypto, non-dollar currencies, and it will become a cat-and-mouse game.
Because their risks are existential, they have a greater incentive to find ways to continue receiving payments beyond our ability to detect.
I am highly skeptical of claims that the blockade alone is sufficient to force the Iranian regime to surrender to a negative agreement.
