Don’t look now. But the pain of rising energy prices may be about to hit Americans a second time.
With no end in sight to the Iran war and oil prices hovering above $100 a barrel, bond traders worried about inflation have been selling off long-term U.S. and developed-world government bonds in recent days. That has the effect of raising bond yields, including benchmarks. 10 year Treasury billup nearly 24 basis points over the past week to close at nearly 4.6% on Friday.
The 10-year Treasury yield affects the cost of mortgages, auto loans, credit card interest rates, and other consumer debt. When it goes up, consumers feel the pinch. Its interest rates are set by the market, not the Federal Reserve.
To find out what’s happening at the intersection of geopolitics, energy, and global debt, CNBC reached out to Daleep Singh, vice chairman and chief global economist at asset management firm PGIM. Singh has seen global energy conflicts up close. As vice presidential national security adviser under President Joe Biden, he engineered the administration’s economic efforts to cut off Russian oil revenues. Earlier in his career, Mr. Singh ran the markets desk at the Federal Reserve Bank of New York, a sensitive position that directly monitored the inner workings of the global financial system.
Mr. Singh may have been appointed by the Democratic Party, but he does not sing the party’s platform. He began by praising conservative economist Kevin Warsh, who was appointed by President Donald Trump and confirmed by the Senate as Fed chairman on Wednesday.
Singh’s transcript of the conversation has been edited for length and clarity. He spoke via Zoom on Friday.
Q: What do you think Kevin Warsh will do as Fed chairman?
Daleep Singh: I’m optimistic about Kevin Warsh. His intellectual work has focused on how to maintain the Fed’s most important asset: credibility. This is never more important than at a time when central banks are under political attack. He will be thoughtful and careful about the tradeoffs necessary to maintain monetary policy independence, perhaps at the expense of other responsibilities the Fed previously had.
It is also very important to have a veteran Fed chairman. Mr. Warsh has lived through the global financial crisis. (Mr. Warsh served on the Fed board from 2006 to 2011.) He was recognized by almost everyone as the Fed’s eyes and ears on Wall Street and how it was doing in terms of communicating its responses to the real economy.
Those who reflexively dismiss him as partisan miss a lot of what he brings to the table in terms of working across the aisle.
That being said, I don’t think the Fed should cut rates at this time. We’ll soon see how much scope he has to do the right thing.
Q: There is a sense that Mr. Warsh will be laughed at for trying to convince the Fed to cut interest rates. Then Trump will explode at him. Are people underestimating his ability to sway Trump?
Singh: The most profound question is whether it is in President Trump’s political interest to force the Fed into easing. Markets are currently pricing in the Fed being more likely to raise rates than ease this year, and for good reason.
We have witnessed a structural failure of the economy. These supply-side shocks are not independent of each other, nor are they average-reversing in terms of their impact on the global economy. They are related and overlap.
If you look at the past five years, we’ve had supply shock after supply shock, from the coronavirus to Ukraine, from tariff changes to immigration restrictions, to now Iran. These are a combination of supply-side shocks that suggest we are entering a structurally higher inflation environment.
Q: On Friday, the yield on the 10-year US Treasury briefly exceeded 4.6%, the highest level in about a year. Yields are rising in places like the UK and Japan. What do you think about the global bond market?
Singh: It’s a byproduct of these forces that we’re talking about. If we’re going to live in a world where budget deficits keep increasing without limit, there’s no political will to do anything about it, and the US at least has a central bank that’s unusually reluctant to raise interest rates, then it makes sense that the yield curve would steepen. Long-term yields will continue to rise as buyers need more compensation for the fiscal and inflation risks they are currently absorbing.
Smart investors will understand that this is a multi-step process, and the US government will also decide how to respond to the rapid and sustained rise in long-term interest rates.
If this continues, and the Treasury yield (10-year bond), for example, rises above 5%, it won’t be long before the Secretary of the Treasury says, “Look, I have a toolkit too, and I’m not afraid to use it.” The Treasury Secretary could shorten the weighted average maturity of Treasury issuances, make more aggressive use of share buyback tools, potentially put the Fed at odds with the market, and say purchases of long-term Treasury bonds may be needed to align with long-term fundamentals.
In other words, it is financial repression (when governments artificially suppress interest rates to make debt more manageable at the expense of risks such as harming savers).
I believe this is the endgame for the bond market, as bond yields above 5% are not sustainable for a variety of reasons.
Q: How big is the risk that the 10-year US Treasury yield will reach 5% in the next few months?
Shin: I think that possibility is high. We are currently in the middle of a bond vigilante trade. This is taking shape in the UK.These movements tend to take on a life of their own, and do not self-correct until policy responses are made.
This is a very smart U.S. government that understands the dynamics of bond markets and knows how to stop yields from rising. Personally, I don’t think the bond/vigilante trade will last long.
Q: Let’s move on to Iran. Can you give your thoughts on what’s going on there?
Singh: I don’t think either side has an escalation advantage, but neither the United States nor Iran fully recognize that reality.
The political and economic costs of a ground invasion that brings about regime change in Iran are too high for President Trump. Not only because of the high casualties on the ground, but also because Iran is certain to further weaponize its asymmetric advantages in the Strait of Hormuz and the Red Sea.
I think Iran also understands that if it gets too involved, it could undermine what Iran is trying to prevent by sending ground troops from the United States.
We are asking both sides to recognize the reality that neither side can overpower the other, which is why we are in this impasse.
Transactions must be guaranteed by a trusted third party. There is currently no trust between the US and Tehran. This is because bombs are dropped every time the two countries engage in negotiations. That’s where China comes in, and I’d like to know more about what was said and agreed in Beijing (during the summit between President Trump and Xi Jinping).
It will probably take another month or two for this kind of agreement to be finalized. Because if it drags on much longer, this will become an unsustainable conflict for the White House.
Q: Still, an additional month or two would be a significant financial pain.
Singh: I was just in Texas. For example, I’ve heard firsthand that the maximum additional production that can be expected from the Permian Basin is around 250,000 barrels per day. This is only part of the shortfall in the Strait of Hormuz. (According to some estimates, the oil market could be facing a shortfall of up to 100 million barrels a week.)
The situation is getting really dire. I think there is still a risk premium. Brent oiland will likely be in the $80 to $100 per barrel range for some time.
Q: How long do you feel Iranians can withstand the kind of economic pressure they are currently under due to the economic blockade?
Singh: In my direct experience in terms of putting maximum economic pressure on dictatorships, necessity is the mother of invention, so the dictatorships envisioned by Western leaders tend to have a much longer runway than democratic regimes. They will develop workarounds to get paid through barter, cryptocurrencies, currencies other than the dollar, and it becomes a cat-and-mouse game.
Their risk is existential, so they have more incentive to find ways to continue receiving rewards beyond our ability to detect.
I was highly skeptical of the claim that a blockade alone would be enough to force the Iranian regime to submit to an unfavorable deal.
