Violent upward repricing of the West Texas Intermediate and Brent Crude since the beginning of summer raised inflation above previously expected levels. Higher for longer monetary policy dominates the narrative and oil dissuaded the bond market of cuts in the near future, although economic conditions are worsening, especially in Europe.

Since June, oil has been skyrocketing as Saudi Arabia cut production and expanded the forecasted demand and supply difference. OPEC expects that in the fourth quarter of the year, there will be a deficit of around 3 million barrels per day which pushed WTI and Brent prices higher. The 10-year German bond yield hasn’t been moving significantly in July and August, however, since the beginning of September, it has risen by 40 basis points to 2.95% even as the economic data shows Europe is on the recessionary path due to renewed inflation concerns. Over the past week, the Bund has been collapsing without any significant news coming from the market except the news on Thursday regarding a decline in oil inventories at Cushing, Oklahoma upon which the Bund plummeted. Oil market tightness is reflected in the heavily backwardated futures curve. Currently, the difference between the first and second contract is around 2.3$ as the plummeting supply is pushing the spread up. Such a backwardated market structure is extremely bullish for the oil prices and might push Brent and WTI above 100$. The lower-than-expected inflation data in Germany did not manage to ease the selling pressure on the Bund. On the contrary, in the US, the economic data is superior to the Eurozone and the economy is resilient. Therefore, the 10-year yield is in a strong upward trend on the soft landing scenario that dominates the narrative. The market is starting to consider Lagarde as a hawk who won’t turn to an expansionary monetary policy easily as well as Powell who is often associated with Paul Volcker, Fed’s former governor who managed to defeat inflation in the 1980s that emerged due to the energy crisis similarly to the situation in 2022 and 2023. Both the US 2-year Treasury and Schatz yield managed to reach levels before the Silicon Valley Bank crisis in March as the market assumed that the rates would be higher for longer as the oil market leaves no other option to the central banks. Also, there is no consensus on the market that the rate hike cycle in Europe is over. In the US, it is fairly certain that one more rate hike is going to be delivered, however, higher oil prices might even push first rate cuts in 2025.

The recent surge in oil prices, driven by supply constraints and rising demand, has had significant implications for global financial markets and monetary policy. Inflation has exceeded expectations, prompting central banks to grapple with the prospect of “higher for longer” monetary policies. This divergence between strong economic data in the US and recessionary signals in Europe has led to a sharp rise in bond yields. Even lower-than-expected inflation in Germany failed to ease selling pressure on Bunds, reflecting concerns about the inflation outlook. The oil market’s tightness, reflected in a heavily backwardated futures curve, suggests bullish prospects for Brent and WTI crude oil, potentially pushing prices above $100 per barrel. The situation parallels the energy crisis of the 1980s and its impact on inflation, prompting comparisons to Paul Volcker’s resolute anti-inflationary measures. While the US anticipates one final rate hike, Europe’s rate hike cycle remains uncertain, and higher oil prices may even prompt rate cuts in 2025. Overall, the evolving economic landscape and oil market dynamics are reshaping bond markets on both sides of the Atlantic.