Duration offers an opportunity as odds grow for Iran off-ramp

Sovereign developed-country bond yields have surged higher in recent weeks, propelled by oil hovering persistently around $100 a barrel and the longer-than-once-expected conflict in the Persian Gulf. Recent inflation data in the US and abroad clearly reflects the surge in energy costs and has fueled concern of potentially broader inflation pressures, forcing central banks to talk tough and building expectations of monetary tightening here and abroad.

Fiscal concerns have also contributed to rising yields — including some governments waiving fuel taxes or offering subsidies to help consumers —  setting off a self-reinforcing negative loop of higher interest costs pressuring already wide government deficits. Lastly, the US economy continues to grow, with two consecutive months of job growth, a stable unemployment rate, generally resilient consumer demand and ongoing AI-fueled capital spending and corporate earnings growth.

But in the end, it all comes back to the Iran conflict. Negotiations between Iran and the US have failed thus far, leaving Strait of Hormuz traffic halted. The recent US-China summit failed to indicate China would push Iran towards a negotiated outcome. That left the markets to react, once again, to threatening language from President Trump alternating with hopeful comments about progress towards a deal over the past weekend. This back and forth inflames the inflation and fiscal fears.

The alternative — a credible deal to reopen the Strait of Hormuz and commence detailed negotiations around nuclear material — likely would do the opposite, forcing yields down. The average yield of the US Treasury index has risen 66 basis points since the start of the conflict. Benchmark 2-, 10- and 30-year yields are trading at yields around key thresholds: 4.00%, 4.50% and 30s  5%, respectively.

The belligerent parties remain somewhat far apart in the negotiations. That said, with market yields having risen so sharply, the building Gulf-regional pressure to find a solution to the Strait and the domestic political pressure on the Trump administration have presented a tactical opportunity for our Duration Committee to lean long.