The Bond Market's Unexpected Reaction to the Iran War: A Closer Look
The Iran war has been a significant event, and the markets have reacted accordingly. However, one area that has caught my attention is the bond market's response, which has been a bit of a surprise.
Initially, the war's impact on oil prices was expected, with a 8% climb, as the attack and potential retaliation were widely anticipated. Trump's statement that the war would last 4-5 weeks helped set a realistic expectation. While the war's duration is uncertain, the possibility of escalation is a concern.
The US dollar's rally was moderate, despite some weakness in the euro due to oil and natural gas risks. I expected the yen to strengthen, but it lagged due to energy worries, which is a worrying sign for its traditional safe-haven status.
The rebound of AUD and CAD on higher commodity prices was predictable. Gold initially rallied but fell back to its starting point, suggesting it will remain in demand as long as the conflict persists, despite seasonal tailwinds. However, the war's end could bring downside risks.
The real surprise was the bond market. US 10-year yields rose 8 bps to 4.04% after falling below 4% last week. This quick turnaround is intriguing, especially as the war doesn't seem too extreme. The technical bounce above 4% is bullish, and with oil prices likely causing inflation concerns, yields could test and break 4.10%, indicating a potential range trade until the economic outlook becomes clearer.
Goldman Sachs also weighed in, noting that rising yields are a puzzle for equities. They cited reasons including the inflationary impact of higher crude prices, large month-end buying in rates, and credit and layoff concerns feeding into Fed cut expectations. This further highlights the complexity of the market's reaction to the Iran war.
