Global financial markets came under renewed pressure on Friday as a sharp surge in oil prices intensified fears that central banks may be forced to keep raising interest rates to contain a fresh wave of inflation.
Brent crude rose to a four-month high of $109.97 a barrel after jumping 6% in the previous session, putting the benchmark on course for a weekly gain of almost 13%. The rally in energy prices has heightened concerns that a prolonged disruption to oil supplies could feed directly into consumer prices and complicate efforts by central banks to bring inflation under control.
The latest escalation in geopolitical tensions has centred on key shipping routes in the Middle East. Oil flows through the Strait of Hormuz remained restricted as the United States and Iran exchanged attacks, while Iran-aligned Houthis seized control of Yemen's port of Mocha, raising concerns over the security of Saudi oil exports through the Red Sea.
"Maritime traffic through the Bab el-Mandeb is gravely imperiled by the Houthi advances," said Helima Croft, head of global commodity strategy at RBC Capital Markets.
Croft warned that the worsening conflict could push Brent crude to $121.99 a barrel later this year if it develops into a full-scale Saudi-Houthi war.
The combination of higher energy prices and mounting geopolitical uncertainty has prompted investors to reassess the likelihood of a prolonged period of tighter monetary policy. Markets that had previously anticipated a gradual easing of interest rates are now increasingly pricing in the possibility that central banks will have to take further action to prevent higher commodity costs from becoming entrenched in inflation.
Comments from President Donald Trump that the conflict could continue beyond the November midterm elections have added to those concerns, contributing to a broad rise in government bond yields.
In the United States, the benchmark 10-year Treasury yield climbed two basis points to 4.9708%, its highest level in three years and just below the closely watched 5% threshold. A sustained rise above that level would further increase borrowing costs across the economy, including for the US government, which carries about $40 trillion in debt.
Longer-term borrowing costs also climbed sharply. The 30-year Treasury yield reached 5.3803%, its highest level in 19 years, a move that threatens to put additional pressure on mortgage rates and further weaken the housing market.
Short-term Treasury yields rose as investors increased their expectations of another Federal Reserve rate increase. The two-year yield gained two basis points to 4.5835%, following a 12-basis-point jump overnight. Markets were pricing in roughly a 70% chance that the Federal Reserve would raise interest rates this month in an effort to prevent rising energy costs from fuelling broader inflation.
The sell-off in US government bonds was compounded by a Treasury buyback programme that attracted less demand than expected, falling short of the anticipated $6 billion value.
Asian Bonds Follow Global Sell-Off
The pressure quickly spread across Asian bond markets.
Australia's three-year government bond yield surged 18 basis points to 5.047%, its highest level in 15 years. In Japan, the 10-year government bond yield rose six basis points to 2.97% after data showed wholesale inflation remained elevated, strengthening expectations that the Bank of Japan could soon raise interest rates.
The prospect of tighter monetary policy is no longer confined to the United States or Japan.
Analysts at JPMorgan now expect eight of the nine developed-market central banks to raise interest rates by the end of the year. The expected increases include the US Federal Reserve, the Bank of Japan, all four major European central banks, and the reserve banks of Australia and New Zealand.
"The tightening is for now expected to remain shallow, but risks to our forecasts lean in the direction of more action in the face of resilient growth, sticky core inflation, and commodity price pressures," JPMorgan analysts said in a note.
The European Central Bank has already raised interest rates twice this year, and some officials believe additional increases could be necessary, with another move in October remaining possible.
Inflation Data in Focus
Attention is now turning to US consumer-price data for August, which could play a decisive role in determining whether the Federal Reserve raises rates at its next meeting.
Economists are forecasting a 0.2% monthly increase in core consumer prices, which excludes volatile food and energy costs. However, the risks are viewed as tilted towards a stronger reading after producer-price data released overnight showed signs that inflationary pressure remained persistent.
The latest oil shock could make the inflation figures even more consequential. Higher fuel and transportation costs can spread through the economy, increasing expenses for businesses and households and potentially making it more difficult for central banks to justify cutting interest rates.
Equities Slide as Borrowing Costs Rise
Higher bond yields also weighed heavily on stock markets as investors reassessed corporate valuations. Rising yields increase the discount rate applied to future corporate earnings, making equities comparatively less attractive and particularly pressuring higher-growth companies.
MSCI's broadest index of Asia-Pacific shares outside Japan fell 1.8%. Japan's Nikkei dropped 2.8%, while Chinese blue-chip stocks declined 1.2%.
Hong Kong's Hang Seng Index also fell 1.5%.
US stock futures were comparatively steadier, with Nasdaq futures down 0.2% and S&P 500 futures little changed.
The US dollar strengthened alongside Treasury yields after gaining 0.4% against major currencies in the previous session. It was last trading around 99.04 on Friday.
Gold, meanwhile, showed only a modest recovery despite the heightened geopolitical uncertainty. The precious metal rose 0.3% to $4,328 an ounce after falling almost 2% overnight, suggesting that it was not attracting the level of safe-haven demand that might normally accompany a sharp escalation in geopolitical and financial-market risks.
For investors, the central question is increasingly whether the oil shock will prove temporary or become a sustained source of inflation. If elevated crude prices persist, central banks could face a difficult balancing act: restraining inflation without inflicting deeper damage on economic growth and already-sensitive housing and financial markets.
The prospect of prolonged conflict, restricted shipping routes and higher energy costs has therefore shifted the market narrative from expectations of eventual monetary easing towards renewed concern about how much further interest rates may have to rise.