The historically close positive correlation between oil prices and 10-year Treasury yields broke after the Fed’s first interest rate cut in mid-September.

In years when oil prices rose, longer-dated Treasury yields, such as the 10-year bond, which are used as indicators of economic and inflationary expectations, also rose. This is because higher crude oil prices push up inflation, and higher inflation increases Treasury yields as the bonds’ fixed payments are eroded by that inflation.

But in the last few weeks, since the Fed’s massive interest rate cut on September 18, Treasury yields have reached a three-month high while oil prices have also seen a lot of volatility.

But earlier this week, oil fell 6% in one day after Israel’s limited response to an October 1 Iranian missile attack avoided any energy infrastructure in Iran. This was the largest daily percentage loss in oil prices in more than two years, with both indicators hitting their lowest levels since September 10 on October 28.

Movements in oil prices in recent weeks have been driven by a combination of geopolitical events, ups and downs in the war risk premium, and concerns about weak global demand and an imminent oversupply in the oil market.

At the same time, the 10-year Treasury yield hit its highest level in more than three months this week, up 60 basis points from a 16-month low in September, just before the Fed’s first rate cut.

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Source: Apollo Global Management

“US long-term interest rates are breaking away from Fed expectations and oil prices. Long interest rates are on the rise, although the market still expects five rate cuts from the Fed over the next 12 months. “Although oil prices are falling, long-term interest rates are rising,” Apollo Chief Economist Torsten Sløk said. wrote on Wednesday.

“This suggests that long-term interest rates are rising due to emerging concerns about fiscal sustainability,” the economist added.

The market is increasingly pricing in Donald Trump’s return to the White House; The promised tax cuts, if implemented, are expected to further increase the US’s huge national debt. Kamala Harris’ presidency is also expected to increase the US debt burden; Some might argue that not as much as the Trump Administration.

The US national debt currently stands at over $35.5 trillion, according to the Treasury Department data.

Nonpartisan Committee for a Responsible Federal Budget analyzed Fiscal and spending plans of two US presidential candidates. It was revealed that Vice President Harris’ plan would increase the national debt by $3.95 trillion by 2035, while President Trump’s plan would increase the debt by $7.75 trillion.

The market view that the U.S. fiscal situation is increasingly unsustainable has sent 10-year Treasury yields rising even as oil prices have fallen amid concerns about weak demand and rising supply.

The rising U.S. national debt could lead to the next financial crisis as both Republican and Democratic political leadership have concluded over the past two decades that budget deficits are not significant. argues Sheila Bair is the former president of the Federal Deposit Insurance Corporation and founding chair of the CFA Institute’s Systemic Risk Council.

“Make no mistake, if we continue down this path investors will eventually lose confidence in our debt,” Bair wrote in an article in Barron’s.

“Private sector borrowing costs linked to treasury interest rates will also rise, harming economic growth.”

The recent divergence between Treasury yields and oil prices may also be the result of a large market bet that Donald Trump will win and expectations of fiscal policy that will crush the budget.

Viraj Patel, global macro strategist at Vanda Research, says the “Trump Premium” in 10-year yields is rising and the disconnect with oil is a sign that bonds are more focused on the US election than anything else. in question earlier this week.

But this particular “Trump trade” may have gotten back on track after Trump supporter Elon Musk. signaled He said last week that a new Trump Administration could begin cutting spending in an effort to make the government more efficient and rein in the debt bubble.

Trump’s White House includes John Paulson as potential Treasury Secretary committed to to cut federal spending.

Written by Tsvetana Paraskova for Oilprice.com.

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