This is Matt Graham with the MBS Live Market Update. For three months, they were almost inseparable. Then in June, they went their separate ways. But now, as US-Iran tensions flare up again, oil prices and bond yields are rekindling that old flame. To be more specific, after the onset of the war, movement in oil prices was highly correlated with the movement in yields, which of course is just another word for rates. The reasoning was simple: higher fuel prices implied higher inflation, and higher inflation tends to result in higher rates, all else equal. The oil versus rates correlation is never perfect but it generally remains strong until ceasefire confirmation in early June. At that point, oil went south, while bond yields decided to stick around at higher levels for their own reasons, and also because gas and diesel prices hadn’t fallen nearly as fast as oil prices themselves due to refinery capacity. Before continuing, let’s be clear on the oil versus rate relationship in the bigger picture. Because fuel is so central to inflation and because inflation is so central to rates, it’s tempting to conclude that oil and rates should always be correlating to some extent. In practice, bonds actually have a lot of other things on their mind besides inflation: economic data, asset allocation trading, foreign demand, and Treasury issuance considerations to name a few. This results in noticeable departures from the correlated trend over the years, even though there is also generally correlation in the big picture All I’m trying to say here is that we shouldn’t always perceive bonds to be at the whim of oil prices, even though there are moments in history where they are intensely correlated for other reasons. In fact, that’s why the recent correlation is understandable given the violence of the move in oil prices combined with a relative absence of other strong motivations for the bond market. That point was driven home two weeks ago when the bond market finally got a big data point that mattered in the form of the jobs report, and it caused a big bond-specific reaction that did not include oil prices. Last week was a different story, of course. Bonds and rates had very little by way of new motivation or data. Meanwhile, the end of the U.S.-Iran ceasefire was very big news for oil. Prices spiked and the apathetic bond market was quickly willing to be taken along for the ride. Most of July has thus seen a high degree of correlation return between oil and yields. The only hitch was on Friday afternoon when bond yields continued to drift a bit higher as oil prices remained lower day over day. And there are a few different ways we can account for that. But the simplest would be that traders were positioning for this week’s testimony from Fed Chair Warsh, which starts tomorrow, as well as two key inflation reports with CPI and PPI on Tuesday and Wednesday, respectively. Adding credence to that theory is the fact that Fed Funds futures actually experienced an even sharper move than longer-term Treasuries, something that suggests that traders were positioning for some Fed-related news or for inflation to imply Fed-related decision-making. Additionally, bonds could have also just been skeptical about the afternoon oil price recovery. If so, that would have been fairly clairvoyant considering over-the-weekend drama in Iran, with more airstrikes on both sides and another leg up for oil prices. If all the above sounds a bit dramatic, mortgage rates agree, and the bigger-picture rates are merely drifting sideways in a fairly narrow range, even though that range is generally near the ten-month highs. But even oil prices are nowhere near their highs from a month ago. If there’s a reason for that, it’s that the market is a bit weary of perpetual war-related headlines, and they take them with a grain of salt, almost as if they are negotiation tactics rather than a sign of an intense resurgence of hostilities. Of course, this can change, and the market is sensitive to that, so we’ll see what the news cycle brings this week. But there could be more focus on the inflation data and Fed Chair Warsh over the next two days, especially. That’s gonna do it for this week. Back to you.
Matt Graham, Founder and CEO, MBS Live
Matt began as an originator in 2002. He fell in love with the idea of following MBS in real-time but felt that existing products were only scratching the surface. Thus was born MBS Live in 2007, the first-of-its-kind platform with real-time market data/analysis, and live chat with analysts, traders, and originators around the country. He is currently the Founder and CEO of MBS Live!
He’s been covering bond/mortgage markets, writing commentary, alerts, and chatting with the live community every business hour of every business day ever since.
Matt also serves as the Chief of Operations for mortgagenewsdaily.com, where he is one of the industry’s most respected mortgage rate experts, frequently quoted in the media. Mortgage News Daily’s rate index is used as the definitive resource on day-to-day mortgage rate averages.
He lives in the Pacific Northwest with his wife and son where he enjoys skiing, fishing, coaching youth sports, playing the guitar, and more DIY projects/hobbies than he’d care to admit.