Oil Returns to $90: Why Global Markets Are Trading Stagflation Again

Original title: Rate-Spike Hedgers Go "Bonkers" As Iran Attacks Spike Oil; Stocks, Gold, & Crypto All Tank
Original author: Tyler Durden, ZeroHedge

Editor's note: On September 1, global markets faced two simultaneous pressures: the US-Iran conflict escalated again, pushing international oil prices sharply higher; and global sovereign bonds extended their sell-off, with Japan's 10-year government bond yield touching 3% for the first time in 30 years. US stocks, gold, and bitcoin fell in tandem, while the dollar and US Treasury yields rose.

More important than the rise and fall of asset prices is that the energy shock is changing the market's judgment on the path of inflation and interest rates. Weak job openings, construction spending, and manufacturing data had pointed to an economic cooling, but rising oil, diesel, and natural gas prices could push overall inflation higher. This leaves the Federal Reserve facing a more difficult combination: growth is weakening, but price pressures may not ease in tandem.

The author, Tyler Durden, interprets this market action as a return of the "stagflation trade." His core judgment is that energy prices, the interest rate market, and risk assets can no longer be priced separately; if refined product prices remain elevated, the Fed's policy space may narrow further, and long-term US Treasuries will continue to face pressure from inflation, fiscal deficits, and AI financing needs.

It should be noted that there is still considerable uncertainty about whether energy prices will continue to transmit to core inflation and whether the Fed will continue to raise rates as employment weakens. The options market has clearly increased bets on interest rate tail risks, but this reflects investors' hedging against extreme scenarios, not that rates have definitely entered an accelerated upward phase.

The following is a compiled translation of the original article:

After the US struck Iranian targets again, international oil prices rose rapidly, and the global bond sell-off intensified. Stocks, gold, and crypto assets came under broad pressure, and market concerns about stagflation and further rate hikes clearly increased.

The US economic data released that day was not strong: job openings, construction spending, manufacturing PMI, and the Dallas Fed services indicator all sent cooling signals to varying degrees. But at the same time, oil prices, refined product prices, and Treasury yields rose in tandem, and the interest rate futures market also increased pricing for a Fed rate hike in September.

This combination forms the core contradiction of this article: economic activity is weakening, but the energy supply shock could push inflation higher again. If price pressures persist, it will be difficult for the Fed to pivot to easing based solely on employment and growth data; but continuing to raise rates amid economic weakness could also amplify pressure on financial markets and the real economy.

Economic data weakens, energy prices rise, and the market begins to reassess stagflation risks.

Crude Oil Breaks Above $90, Real Pressure Comes from Refined Products

After the US launched a new round of strikes on Iran, the market began to reassess the possibility of prolonged disruption to energy transport through the Strait of Hormuz. US crude oil futures briefly rose above $90 per barrel, hitting a new high since late July.

Spot Brent crude prices rise but remain roughly within the recent trading range

Iran's Islamic Revolutionary Guard Corps subsequently warned that the US would face "severe punishment." The US continued to pressure Iran through military action and sanctions. The duration of the conflict, Iran's response, and whether shipping security deteriorates further have become the main variables in short-term crude oil market pricing.

US Treasury Secretary Bessent downplayed the long-term strategic value of the Strait of Hormuz. He said Gulf countries are accelerating the construction of onshore oil pipelines, and oil transport could bypass the strait in two years. However, this statement describes future alternative transport capacity and cannot eliminate current supply and shipping risks.

From the spot market perspective, spot Brent crude prices have risen but remain roughly within the recent trading range. Rich Privorotsky, head of Goldman Sachs' Delta One trading desk, believes the market pressure comes not only from crude oil prices; signals from refined product and natural gas markets are more severe.

European natural gas prices have risen to about a three-and-a-half-year high, heating oil is near recent peaks, and US diesel crack spreads have hit records. Crack spreads measure the difference between refined product prices and crude oil costs, typically reflecting supply-demand tightness in the refining sector.

US diesel crack spreads hit records, with refined product markets sending stronger supply tightness signals than crude oil

This means that even if crude oil prices do not sustainably break out of the recent range, the prices consumers actually pay for diesel, heating oil, and other fuels could still rise. Lower crude oil prices may not directly translate into lower end-user prices; some of the spread could turn into higher refining margins.

Privorotsky judges that if refined product prices remain at current levels, overall inflation could face renewed upward pressure in the coming months. Whether energy price increases eventually spread to core inflation remains the key to determining policy impact: a one-off supply shock may not change the medium-term inflation trend, but if transportation, production, and service costs continue to rise, price pressures could gradually transmit to other sectors.

According to market data cited in the original article, since February, global refined product wholesale prices have risen by an average of about $40 per barrel, with diesel contributing more than 40% of the increase. Over the same period, global refined product exports fell by about 6 million barrels per day year-on-year, with the Persian Gulf region and Russia accounting for about three-quarters of the decline. Since this data comes from trading desk analysis, it should be viewed as the statistical caliber of the relevant institution, not official unified data.

Global refined product exports decline year-on-year, with the Persian Gulf region and Russia as the main drags

Oil Prices and Interest Rates Re-Link, Stagflation Trade Returns

Privorosky believes it is difficult to discuss the energy market separately from the interest rate market in the short term. Rising oil and refined product prices could push up inflation expectations, and investors then demand higher bond yields; higher yields in turn depress valuations of risk assets such as stocks.

This trading relationship was particularly evident on September 1. US Treasury yields rose across the board, with larger increases at the short end, and the yield curve showed a "bear flattening."

Bear flattening refers to a general decline in bond prices and an overall rise in yields, while short-end yields rise faster than long-end yields, causing the yield curve to flatten. This typically means the market has raised expectations for near-term rate hikes or continued policy tightening.

On that day, oil prices rose, and manufacturing surveys continued to show price pressures, so market bets on a Fed rate hike in September clearly increased. The original article said the probability briefly exceeded 70% intraday; other public market measures showed the probability at around 65% to 70% at the time. Different data may come from different sampling times and contract calculation methods, so they should not be forcibly unified.

This pricing was also influenced by Fed Chair Kevin Warsh's earlier hawkish remarks. Oil price increases were not the only reason for rising rate hike expectations; more precisely, the energy shock reinforced inflation concerns already formed in the market.

The author summarizes the current environment as a typical stagflation combination: growth and employment data are weakening, while energy costs are rising. The related "stagflation asset portfolio" has performed relatively well recently, also reflecting that some investors are positioning for a scenario of slowing growth and sticky inflation.

However, whether oil price increases can change Fed decisions still depends on their duration and transmission to core prices. If energy prices fall back quickly, the policy impact may be relatively limited; if diesel, natural gas, and transportation costs remain high for a long time, the risk of inflation spreading again will clearly rise.

Global Bonds Under Pressure, Treasury Buybacks Cannot Offset Supply Pressure

Before the energy shock arrived, the global bond market was already in a sell-off. On September 1, the global sovereign bond composite yield rose to near its highest level since 2008, and Japan's 10-year government bond yield touched 3%, the first time since 1996.

Japanese government bonds are particularly affected by inflation, fiscal expansion, and expectations of further rate hikes by the Bank of Japan. US, German, and UK government bond yields also generally rose, showing this is not a localized fluctuation in a single market.

US long-term Treasuries face additional pressure. The original article points out that the 30-year Treasury yield rose in early trading, briefly erasing the decline that had occurred after the Treasury expanded its liquidity support buybacks for long-term bonds.

The US Treasury previously announced that it would increase the size of each liquidity support buyback for 10- to 30-year Treasuries from a maximum of $2 billion to at least $4 billion, with the new arrangement to begin on September 9. Buybacks can improve liquidity and trading conditions for older bonds, but they do not directly reduce the Treasury's net financing needs, nor are they equivalent to Fed quantitative easing.

30-year Treasury yields rise again, briefly erasing the decline after the Treasury announced expanded long-term bond buybacks

Priya Misra, portfolio manager at J.P. Morgan Asset Management, believes Treasury buybacks may provide some demand for long-term bonds, but could be overwhelmed by financing supply from AI infrastructure construction. The "AI supply pressure" here mainly refers to increased bond issuance by large technology companies, utilities, and data center operators to build computing power, electricity, and supporting facilities.

At the same time, the US fiscal deficit, continued government bond issuance, and a new round of corporate bond issuance are all increasing the supply of long-duration assets. John Briggs, head of US rates strategy for North America at Natixis, judges that until welfare spending reform truly changes the fiscal deficit outlook, long-end yields may remain elevated; in his view, Treasury buybacks are still just "a drop in the bucket" relative to overall bond supply.

This is also the difference between this round of long-end rate pressure and simple rate hike expectations. The short end mainly reflects the Fed's policy path, while the long end must also digest inflation risk, fiscal deficits, term premiums, and bond supply. Even if the Fed does not continue to raise rates, long-end yields may not fall back quickly.

Rate Tail Risks Heat Up, Options Market Wary of "Negative Convexity"

While the cash bond market declines slowly, some investors are buying large amounts of high-strike rate payer options, i.e., options that bet on a sharp rise in future interest rates.

Nomura strategist Charlie McElligott points out that demand for medium-term, high-strike payer options has increased significantly, with some demand coming from a large buyer who is not a regular participant. These trades have pushed up payer skew, meaning options bought to hedge against rising rates have become more expensive relative to options for falling rates.

But the overall volatility of interest rate swaptions has not risen sharply in tandem with yields. The reason is that the bond market currently looks more like a sustained, slow sell-off rather than a short-term violent loss of control. Realized volatility is low, but investors keep buying extreme upside protection, creating a mismatch between spot market moves and tail risk pricing.

The "volatility of volatility" in rates rises rapidly, showing significantly stronger hedging against rate tail risks

The risk is that if rates shift from a slow rise to an accelerated rise, market makers may need to concentrate hedging of previously sold high-strike options. Since the market may not have enough counterparties to provide opposite positions, such hedging could further amplify rate volatility, creating a so-called "negative convexity" moment.

Negative convexity means that after rates change, some market participants are forced to add hedges in the direction of the move: the more rates rise, the more they need to add rate-up positions, which could push rates even higher. Current options demand shows investors are guarding against this risk, but it does not mean this scenario will necessarily occur.

Going forward, the market needs to watch three sets of variables: first, whether the US-Iran conflict and Strait of Hormuz shipping continue to affect energy supply; second, whether diesel, natural gas, and other end-user energy prices can persist and transmit to core inflation; and third, whether the degree of weakening employment data is enough to stop the Fed from continuing to tighten policy.

If energy prices remain high, inflation expectations continue to rise, and bond supply pressure does not ease, the stagflation and rate tail risk logic proposed by the author will be strengthened. Conversely, if energy supply recovers, refined product spreads fall back, or employment deteriorates significantly enough to force the Fed to prioritize growth risks, the foundation of this rate-up trade could weaken.