Even if the conflict in Iran subsides quickly, international crude oil supply may not recover to pre-war levels. Bank of America strategists warn that if oil prices continue to rise over the next three to six months, global interest rates will still have significant room to rise, and the Federal Reserve may be forced to restart tightening, with short-term US Treasury yields facing particularly intense pressure.

Data supports this: Oil prices and short-term interest rates are highly correlated.

In their latest research report, Bank of America strategists Ralph Axel and Oliver Levingston analyzed decades of data and found a strong correlation between oil prices and interest rates in the US, UK, and German markets. The yield on the US two-year Treasury note has risen by 111 basis points overall this year. Breaking it down, yields have cumulatively increased by approximately 196 basis points on trading days with rising oil prices, and decreased by a cumulative 83 basis points on trading days with falling oil prices. The correlation is even more pronounced in the UK and German markets. The strategists point out that rising oil prices have a greater impact on short-term interest rates, while the impact on long-term term premiums is limited; monetary policy expectations are the dominant variable.

Transmission logic: Oil prices surge → inflation expectations rise → forcing central banks to raise interest rates

The rise in energy prices has a clear transmission chain: soaring crude oil prices raise inflation expectations, bond investors demand higher compensation, driving up bond yields; the market then prices in the central bank's interest rate hikes in advance, ultimately forcing policymakers to deliver on their expectations of interest rate increases.

The Federal Reserve's advantage: The US economy is more resilient and has a greater tolerance for interest rate hikes than other economies.

Compared to the Bank of England and the European Central Bank, the Federal Reserve has relatively ample policy buffer space. With robust US consumer spending, better-than-expected GDP growth, and a resilient labor market, the US economy will be more able to withstand shocks should a new round of interest rate hikes begin.

Risks have not been cleared: the market pricing war has ceased, but supply risks persist.

The market has already priced in expectations of a de-escalation in the Iranian conflict, with crude oil futures prices falling significantly since before the midterm elections. However, the possibility of another surge in oil prices cannot be ruled out, as the volatile situation in the Middle East and the escalation of the Russia-Ukraine conflict are potential triggers. Both strategists emphasized that the duration of geopolitical conflicts is difficult to predict, with the Russia-Ukraine conflict being a prime example. Even if the Iranian conflict eases quickly, Gulf oil production capacity may not recover smoothly, and Ukraine's attacks on Russian refining facilities may not cease, leaving long-term uncertainty on the supply side.

Trading Views and Policy Concerns: We recommend establishing a 2-year fixed-rate position.

Given the strong correlation between oil prices and interest rates, Bank of America recommends establishing fixed-term positions in the US two-year interest rate. Strategists believe the Federal Reserve will not go against market expectations of rate hikes already priced in. The new Fed chair has not yet established sufficient credibility in the fight against inflation; if the Fed chooses to hold rates steady at a policy meeting where the probability of a rate hike is priced in above 50%, it could lose control of long-term interest rates, triggering greater volatility in the bond market.