Things aren’t always as simple as they seem. Let’s hope that’s the case for bonds, because things seem tragically simple when we try to reconcile the two available paths ahead. On one hand, if the Ukraine situation continues to spiral, commodity prices continue to rise. Inflation implications soar, and bond yields are pulled along for the ride. On the other hand, if the Ukraine situation improves, bonds lose their safe haven bid status which is currently the only thing keeping 10yr yields under 2% (and maybe under 2.2% at this point).
Why 2.2? Let’s consider where yields were before the Ukraine invasion.
Then let’s consider that the safe-haven benefits for the bond market seem to have stalled out at 1.71. If that’s not as obvious based on the chart above, it’s easier to see with hourly candlesticks for the domestic trading session in the chart below. This chart also suggests an important pivot zone overhead between 1.88 and 1.91.
Why are we seeing the resistance bounce in bonds? This is a fair question because stocks continue to press new longer-term lows as the flight to safety continues in response to Ukraine. Normally a flight to safety benefits bonds as well. In fact, it has done just that on many occasions recently. But in the past week, we’ve seen a clear break from that trend with bonds increasingly convinced to care more about oil than stock prices.
Oil prices are an obvious consideration for bonds, but not always a driver. It’s been hard to separate out their impact during the Ukraine invasion if we’re simply looking at 10yr yields. After all, 10yr yields have an inflation component and a “real” (inflation-adjusted) component. Real yields are still pricing in the flight to safety, currently trading close enough to all-time lows. Inflation implications on the other hand are at the highest levels in decades.
To bring all of the above together, here’s how that orange line (implied inflation) has correlated with oil prices:
Granted, it’s not a perfect 1:1, but at the very least, oil prices don’t seem likely to argue for a decline in inflation expectations at the moment. Until and unless that miraculously changes, bonds could remain under pressure.