Some relationships are complicated. Oil prices and interest rates are a perfect example.
For about three months, they were practically finishing each other’s sentences, moving almost in lockstep. Then June rolled around, and they decided they needed a little space. But now that July is here, it looks like they’re cautiously seeing each other again.
Back when the Iran conflict heated up, the connection between oil prices and interest rates (represented by 10-year Treasury yields) was hard to miss. The logic wasn’t exactly rocket science: higher oil prices tend to push fuel costs higher, higher fuel costs can drive inflation, and higher inflation usually nudges interest rates upward.
Of course, this relationship has never been flawless, but it stayed remarkably consistent until the ceasefire was confirmed in early June. Once that happened, oil prices headed downhill while the bond market lingered for reasons of its own. One reason? Gas and diesel prices weren’t nearly as eager to fall as crude oil prices were.
Before we crown oil as the permanent boss of interest rates, it’s worth remembering that the bond market has plenty of other things competing for its attention.
Yes, energy prices play an important role in inflation, and inflation is one of the biggest drivers of interest rates. But bonds also care about economic growth, Federal Reserve policy, employment data, investor sentiment, and just about everything else that can keep financial markets awake at night. That’s why oil and rates sometimes dance together—and other times barely acknowledge each other across the room.
Even so, the recent reunion makes sense. Oil prices moved dramatically, and there simply weren’t many other major stories pulling the bond market in different directions.
Last week’s jobs report was the exception. That report gave bonds plenty to think about all by themselves, leaving oil sitting quietly on the sidelines.
This week, however, was a different story. Economic data was relatively quiet, while news surrounding the end of the U.S.-Iran ceasefire grabbed the headlines. Oil prices jumped, and the bond market—without much else demanding its attention—was happy to tag along.
As the chart above illustrates, July has brought a noticeable return to the oil-and-rates connection.
The only wrinkle appeared Friday afternoon. Treasury yields continued drifting higher even though oil prices had already given back some of their gains. There are several possible explanations, but the simplest is that traders were getting into position ahead of next week’s testimony from Fed Chair Warsh, along with two closely watched inflation reports.
Supporting that theory is the fact that Fed Funds Futures reacted even more sharply than longer-term Treasury yields, suggesting markets were already looking beyond oil and focusing on upcoming Fed-related developments.
If all this sounds like a lot of market drama, mortgage rates have remained surprisingly calm.
Treasury yields may look like they’re on an emotional roller coaster when viewed up close, but mortgage rates continue to drift sideways within a relatively tight range. Granted, it’s a range that’s hovering near the highest levels seen in the past 10 months—but compared to all the excitement elsewhere, that’s practically a relaxing vacation.
