Markets can't ignore the war anymore

Oil prices are edging closer to the $100 mark per barrel once again, with diesel fuel futures reaching record highs. The rising energy costs are no longer an abstract concept for investors, as they start to acknowledge that the turmoil in Iran is a reality they cannot afford to ignore. Higher energy prices are seeping into every aspect of the global economy, putting pressure on businesses, households, and governments worldwide.

This surge in energy costs has forced central banks to raise borrowing rates, which in turn worries policymakers across the developed world. The story began in July after a series of attacks on commercial vessels in the Strait of Hormuz reignited hostilities. President Trump declared the memorandum of understanding between the U.S. and Iran null and void.

Oil prices have since climbed from the low $80s to $95 per barrel, marking a significant upward trend. The yield on the 10-year Treasury bond, which serves as a gauge for mortgages and other loans, has climbed to 4.8%, its highest level in nearly three years. Similarly, global government bond yields are at multiyear highs, with the U.K.'s 10-year gilt and Germany's long bond hitting record highs.

Even Japan, an oil-importing country, experienced its highest bond yield since 1996. As energy prices rise, inflation expectations climb, causing government bond yields to soar as investors seek higher returns to offset the eroding value of their money. This inflationary pressure is also altering stock valuations, with analysts suggesting that future earnings may appear less appealing when higher inflation is factored in.

The connection between oil prices and the 10-year Treasury yield is near its strongest in five years, while the inverse relationship between stocks and oil is nearing its most negative in recent times. While government bond yields are influenced by various factors, including budget deficits and geopolitical uncertainties, the war between the U.S. and Iran has undoubtedly amplified the upward pressure on yields.

The initial market shock following the outbreak of the U.S.-Iran conflict in March has given way to steady recovery, albeit with some energy prices remaining elevated. Diesel fuel, a vital component in transportation and manufacturing, is experiencing an all-time high in futures prices.