Elevated uncertainty drives Treasury yields higher

US Treasury (UST) yields have increased sharply during the now month-long Iran conflict as surging oil prices prompted a drastic shift in expectations for central bank policy globally. The sudden and potentially prolonged inflation impact has dominated investor views in the near term, trumping the growth concerns that arise in any energy supply shock. Federal Reserve easing has been priced out and some tightening has been priced into the market. 

Although the 70’s oil shortages are being referenced daily, modern economies are much more efficient compared to 50 years ago in terms of growth per unit of fossil fuel consumption. This explains why the weighted average yield of the US Treasury index has risen a bit over 50 basis points (bps) during the conflict. That said, we expect growth concerns to emerge and risk asset market sentiment to erode the longer oil prices remain elevated.

For now, uncertainty remains very high as indirect negotiations have begun with the adversaries staking out widely divergent positions. We may be in a holding pattern while more US forces make their way to the region to ramp up pressure on Iran. President Trump seems unlikely to unilaterally disengage so long as the Strait of Hormuz remains effectively closed. With Iran still able to launch missiles (albeit in much lower volume than earlier in the war) and to clog the Strait, the Iranian regime continues to have leverage in a negotiation despite the massive asymmetry in military power. Nonetheless, indirect negotiations may create an opportunity for tactical yields to decline somewhat. In addition, a stalemate while more forces move towards the region may also offer a temporary retracement in bond yields.

Although visibility is admittedly low, the Federated Hermes Duration Committee believes a tactical move to a slightly longer duration positioning is appropriate, subject to reevaluation as the situation unfolds.