Don’t look now, but the pain of higher energy prices could hit Americans twice as hard.
With no end in sight to the war in Iran and oil prices stuck above $100 a barrel, bond traders worried about inflation have sold long-term government debt in the US and developed economies in recent days. This has the effect of raising bond yields, including benchmark 10-year treasury noteWhich ended Friday at close to 4.6%, up nearly 24 basis points over the past week.
The 10-year Treasury yield affects the cost of mortgages, auto loans, credit card rates and other consumer loans. When it increases, consumers feel discomfort. Its rate is set by the market, not the Federal Reserve.
To uncover what’s happening at the intersection of geopolitics, energy and global debt, CNBC reached out Dalip SinghVice President and Chief Global Economist of asset manager PGIM. Singh has seen global energy conflicts closely: A.S. Deputy National Security Advisor Under President Joe Biden, he designed that administration’s economic effort to cut off Russia’s oil revenues. Early in his career, Singh ran the Markets Desk of the New York Federal Reserve Bank, a sensitive post that looks directly into the depths of the global financial system.
Singh may have been appointed by a Democrat, but he is not toeing the party line. He began by praising Kevin Wersh, the conservative economist appointed by President Donald Trump and confirmed by the Senate on Wednesday to chair the Fed.
The transcript of Singh’s conversation has been edited for length and clarity. He spoke on Zoom on Friday.
Question: How do you think Kevin Warsh will fare as Fed chairman?
Dalip Singh: I am optimistic about Kevin Varsh. His intellectual work focuses on how to maintain the Fed’s most important asset, which is its credibility. This could not be more important at a time when the central bank is under political attack. I think he will be thoughtful and deliberate about evaluating the trade-offs required to maintain monetary policy independence, maybe to the detriment of other responsibilities the Fed once held.
It is also very important to have a Fed Chairman who is battle-tested. Warsash is going through the global financial crisis. (Warsh was a Fed governor from 2006 to 2011.) Almost everyone credited him with being the Fed’s eyes and ears on Wall Street, and in terms of transmitting feedback to the real economy about how it was doing.
Those who dismiss him as blatantly partisan are missing much of what he brings to the table in terms of working across the aisle.
Having said that, look, I don’t think the Fed should cut rates right now. We’re going to find out really soon how much leeway he has to do the right thing.
Q: There is a perception that Warsh will try to convince the Fed to cut rates and get laughed out of there. Then Trump will turn on him. Are people underestimating? His ability to influence Trump?
Singh: The deeper question is whether it is in President Trump’s political interest to prompt the Fed to ease. The market is now forecasting a Fed hike more likely than tapering this year, and for good reason.
We have seen a structural breakdown in the economy. These supply-side shocks are not independent of each other, and they are not necessarily game-changing in terms of their impact on the global economy. They are related and overlapping.
Looking at the last five years, we have had nothing but supply shocks one after another, from Covid to Ukraine, tariff changes to immigration restrictions and now Iran. These are overlapping supply-side shocks that suggest to me that we are headed into a structurally higher inflation environment.
Why: The 10-year Treasury yield topped 4.6% at one point on Friday, the highest in nearly a year. is produced in UK, Japanand are increasing elsewhere. What is your prognosis for the global bond market?
Leo: It’s a product of the forces we’ve been discussing. If we’re going to live in a world in which Fiscal deficit Keep increasing indefinitely, there’s really no political will to do anything about it, and you have, at least in the US, a central bank that is, let’s say, characteristically hesitant to increase, so it just stands to reason that the yield curve is going to rise sharply. Long-term yields will continue to rise, as buyers need more compensation against the fiscal risk and inflation risk they are absorbing now.
Savvy investors will understand that this is a multi-step process, and the US government will also have to decide how to respond to a sharp and sustained rise in long-term yields.
If this continues, and let’s say Treasury yields (on the 10-year note) rise to 5% or higher, it won’t take much for the Treasury Secretary to say, “Listen, I have a toolkit too, and I’m not afraid to use it.” The Treasury Secretary could reduce the weighted average maturity of our debt issuance, make more aggressive use of buyback tools, and potentially tighten up the market with the Fed saying we have to engage in long-term bond purchases to align with long-term fundamentals.
In other words, it is financial repression (when the government artificially keeps interest rates down, making debt more manageable at the expense of hurting savers, among other risks).
I think this is the end game for the bond market, as bond yields above 5% are not sustainable for many reasons.
Question: How big is the risk of the 10-year Treasury yield reaching 5% in the next few months?
Lion: I think it’s possible. We are at the peak of the bond-vigilante trade right now. This is taking shape in the UK. These steps have an impact on one’s own life, and they do not correct themselves unless there is a policy response.
This is a very savvy US government that understands bond-market dynamics and knows well how to prevent yields from rising. I personally don’t think the bond-vigilante business will survive for very long.
Question: Let’s turn to Iran. Can you tell us your thoughts on what’s happening there?
Singh: I think neither side has the dominance to escalate tensions, but neither the US nor Iran fully realizes this reality.
The cost politically and economically of a ground offensive to effect regime change in Iran is too high for President Trump, not only because of casualties on the ground, but also because Iran would undoubtedly further weaponize its asymmetric advantage in the Strait of Hormuz and the Red Sea.
As for Iran, I think it also understands that if it overplays its role, it could end up destroying what it’s trying to prevent, which is what the United States is sending ground forces to prevent.
We need both sides to recognize the reality that neither side can subdue the other, and that is why we are in this impasse.
Any deal must be guaranteed by a trusted third party. There is no trust at all between America and Tehran at this time, because whenever they sit for talks, bombs are falling. This is where China comes in, and I would be interested to hear more details about what was said and what was agreed in Beijing (during Trump’s summit with Xi Jinping).
We’re probably a month or two away from that type of agreement, because if it goes on much longer it will become a volatile struggle for the White House.
Q: Still, it will take another month or two severe financial hardship.
Lion: I was just in Texas. I heard firsthand that the most that could be expected Permian BasinFor example, in terms of additional production, there is about 250,000 barrels per day. This is a small part of the reduction in the Strait of Hormuz. (According to some estimates, the oil market could be short by as much as 100 million barrels per week.)
The situation is really becoming frightening. I think we will have a risk premium for a long time brent oilAnd in the near future it is going to be between $80 to $100 per barrel.
Why: What is your opinion about how long the Iranians can withstand the economic pressure they are facing due to the blockade?
Singh: My direct experience, in terms of applying maximum economic pressure on an autocratic regime, Western leaders believe that their runway is much longer than that of a democratic one, because necessity is the mother of invention. They will develop solutions to get paid through barter arrangements, through crypto, through non-dollar currencies, and it will become a cat and mouse game.
Because their risks are existential, they have greater incentive to find ways to continue getting paid that are beyond our ability to detect.
I am very skeptical of claims that the blockade in itself is enough to force the Iranian regime to capitulate to an unfavorable agreement.