Why are US bond yields rising? Is it the Iran war or a stronger economy?

US Treasury Secretary Scott Bessent claims the US economy is strengthening, and he anticipates a decline in inflation and bond yields once the Iran conflict concludes. Bessent attributes the recent surge in inflation and bond yields predominantly to the energy crisis brought on by the war. He notes that headline inflation stands at approximately 3.5%, while underlying inflation is considerably lower, at about 2.3% when volatile food and energy prices are excluded.

Bessent believes the energy shock from the Iran conflict is temporary, asserting that energy prices should decrease when the conflict concludes, potentially bringing both inflation and long-term bond yields down. He also highlights job growth as evidence of the US economy's robustness, with roughly 1 million private-sector jobs created this year, while government employment has dropped by around 300,000 jobs.

Bessent emphasizes that private-sector job growth signifies real wage growth. Economic experts, however, hold differing views on the strength of wage growth. Gregory Daco, chief economist at EY, points out that average hourly earnings only increased by 3% in September, the slowest pace since the pandemic. He anticipates inflation to remain high, with the September Consumer Price Index (CPI) possibly showing 3.6% inflation.

Daco suspects this could lead to a 0.6% decline in real wages year-over-year, indicating workers are losing purchasing power. This income pressure could slow consumer spending and result in six consecutive months of falling real wages since the Iran war began, potentially dampening consumer spending growth into 2027. Joe Brusuelas, RSM's chief economist, also acknowledges the US economy's growth in the third quarter but believes inflation has not eased sufficiently, causing higher prices to stress wages and household purchasing power.

Brusuelas expects the next CPI report to show flat or negative real wage growth since the Iran war started, suggesting that rising prices, particularly energy costs, are eating into workers' income. He predicts that weaker real wages could contribute to economic growth slowing down. The debate over bond yields revolves around two primary explanations: higher oil prices due to the Iran war or a stronger US economy.

Bessent leans more towards the energy shock, whereas several Federal Reserve policymakers attribute the rise in yields to economic strength. Bessent attributes the rise in bond yields to higher headline inflation caused by the Iran conflict and the subsequent surge in energy prices. He expects yields to fall after the war ends, possibly reverting to levels seen in mid-February, before the conflict began.

He also foresees mortgage rates dropping if energy prices fall. Federal Reserve officials, however, emphasize economic strength as a major reason for higher long-term yields. Fed Chairman Kevin Warsh recently stated that economic strength is the primary driver of long-term Treasury yields, while Cleveland Fed President Beth Hammack noted that recent growth numbers have been solid, and company earnings have surpassed expectations.

Hammack believes markets are starting to price in ongoing economic strength. Signs of a resilient economy, such as strong consumer spending, investment linked to the AI boom, and stable employment, are bolstering expectations for stronger growth.