Correlation between oil and US Treasury yields: WTI, Brent, 10-year yields

Oil prices and U.S. Treasury yields are closely linked, adding to pressure on the market as investors grapple with concerns about rising inflation.

The one-month rolling correlation between West Texas Intermediate crude oil and the 10-year Treasury yield rose to 0.96 last month, according to BMO Capital Markets. This is the strongest positive relationship since June 2019 and since October 2014 before that.

This synchronized move comes as oil prices have soared due to conflicts in the Middle East, with the benchmark 10-year U.S. Treasury yield briefly exceeding 5% on Monday for the first time since October 2023.

The closeness of the relationship means that any further rise in oil prices could increasingly ripple through financial markets through higher inflation expectations, higher Treasury yields and higher borrowing costs, while potentially prolonging the Federal Reserve’s tightening of monetary policy, industry veterans say.

“The main effect is that the oil shock is spilling over more directly into financial conditions,” said Billy Leung, investment strategist at Global XETF. “Higher oil prices could push up inflation expectations, delay Fed easing, and raise the discount rates applied to stocks and credit at the same time.”

“This makes energy headlines more important to the broader market and reduces some of the diversification benefits that investors typically expect between commodities and government bonds,” he added.

The impact is felt across asset classes.

Rising U.S. Treasury yields will raise financing costs for companies and reduce the relative attractiveness of stocks, while expensive oil will squeeze margins for companies that rely on energy and transportation.

Growth and technology stocks can be especially risky because their valuations depend heavily on expected returns in the distant future.

Ed Yardeni, president of Yardeni Research, said the chain is increasingly moving from energy to inflation to bonds to monetary policy to stocks.

“It’s certainly bad news if oil prices continue to rise, which would signal that bond yields are rising. Then rising inflation expectations increase the likelihood of a tightening cycle in terms of the federal funds rate,” Yardeni said.

“It’s not a one-and-done rate hike, but there could be two or three rate hikes in the future, and that could certainly be worrying for the stock market.”

Komal Srikumar, president of Srikumar Global Strategies, is already steering investors away from assets most vulnerable to rising interest rates. While he favors short-term bonds and defensive stocks, he recommends physical assets such as real estate, copper and gold as hedges. He said tech growth stocks are more vulnerable as interest rates remain high.

“Bonds will be in a bear market and yields will rise. I don’t see anything stopping oil and gas prices from rising,” Srikumar said.

Consumers are facing a similar double whammy.

Andy Lipow, president of Lipow Oil Associates, said higher energy prices directly affect gasoline prices and indirectly affect goods and services shipped by truck or rail, while rising U.S. Treasury yields affect mortgages, auto loans and other borrowing costs.

“Higher WTI oil prices and higher Treasury yields are both bad news for consumers,” Lipow said.

For companies, higher yields also raise the cost of financing inventory and investments, which could weigh on capital-intensive projects like artificial intelligence and building the energy infrastructure needed to support it, Lipow said.

The relationship between oil and the Treasury is growing closer, but that may not be the case if global tensions recede.

Leung said the correlation, which is unusually high at 0.96, could ease quickly if geopolitical tensions ease or growth concerns begin to prevail. Lipow similarly said the scale partly reflects the relatively short time since the U.S.-Iranian conflict began.