US Real Yields Pose Risks To Oil Rally

By Nour Al Ali, Bloomberg Markets Live reporter and strategist

While there are many reasons to be bullish on oil, a contrarian view signals prices may fall in coming months so long as real interest rates keep rising.

The breakdown in the relationship between crude and real interest rates may result in a decrease in oil prices. Take a look at the correlation between WTI contracts and US 10-year real rates (ie the 10-year yield adjusted for inflation), measured on a 120-day basis. The relationship between the two assets has weakened after it was positive last year, when energy was the main driver of inflation and central banks kept raising rates in an effort to control price pressures.

Investors are now concerned about higher rates impacting demand for energy, leading to a supply surplus that could potentially leave more oil out there than buyers want. While there’s a growing chorus that believes the Fed will pivot, policymakers have kept up their hawkish calls for further rate increases despite a recent moderation in inflation. This is because inflationary pressures have become more ingrained in daily life and are no longer solely driven by temporary factors.

There are plenty of other factors that are influencing oil prices, mainly OPEC+’s control over supplies to maintain market stability, and an increase in expected demand out of China. Although traders have already taken these bullish factors into account, the risk remains that rising oil prices may be vulnerable to rising interest rates. The “don’t fight the Fed” concept may become increasingly relevant in this sector of the market.