Oil Prices and US Treasury Yields Correlate at 36-Year High
West Texas Intermediate (WTI) crude oil prices have reached their closest rolling correlation with the 10-year US Treasury yield since around 1990, described by the market as the strongest synchronization in nearly 36 years.
The 3-month rolling correlation coefficient provided by the Chicago Board Options Exchange (CBOE) Macro Volatility Summary rose to 65% last week, surpassing the lows during the COVID-19 pandemic and the highs during the Arab Spring in 2011, and just slightly below the 66% seen at the onset of the Gulf War in 1990. Another measure indicates that the 1-month rolling correlation between WTI near-month contracts and the 10-year yield reached 0.96 in mid-September, nearly a perfect alignment. BMO Capital Markets noted that this 1-month reading is the strongest since June 2019, with a historical comparison to the oil market pressure period in October 2014.
This synchronized rise is occurring during a supply shock rather than a demand expansion phase. The Strait of Hormuz typically carries about 20% of global oil exports, and conflicts have driven up crude oil prices, with WTI near-month contracts briefly exceeding $100 per barrel. The 10-year US Treasury yield has also risen to near its highest level since 2007, recently trading around 5.24%. The CBOE Oil Volatility Index (OVX) has climbed to a multi-month high. Potomac statistics show that at the beginning of the year, a 1% increase in Brent had almost no impact on the 10-year yield, rising to about 1.2 basis points in August and approximately 1.3 basis points in September.
Historical reference points focus on supply disruptions: Iraq's invasion of Kuwait in 1990, North African turmoil in 2011, and oil market pressures in 2014 and 2019. This round combines triple-digit oil prices, the Federal Reserve still tightening, and geopolitical premiums, differing from previous rounds of single oil market shocks. Demand-driven oil price increases typically raise growth expectations, which do not stabilize bond direction; supply-driven oil price increases directly enter inflation expectations, forcing bonds to require higher nominal yields.
A 1-month correlation of 0.96 means that for every effective fluctuation in oil prices, the 10-year yield almost reacts in the same magnitude, temporarily merging two previously separable trading assets into the same macro factor. A 3-month correlation of 65% indicates that even after extending the window, it has not diminished. Correlation is not causation, but the pricing chain has changed to: Strait risk premium → crude oil → inflation expectations → term premium and policy path repricing → nominal yields.
In market mechanics, the buying side consists of bond shorts and commodity longs pricing Middle Eastern premiums as inflation, while the selling side includes Treasury buyers needing lower duration or higher coupon rates. Funds are flowing from long-duration Treasuries to short-duration cash, energy stocks, and inflation-protected securities. Beneficiaries are accounts holding crude oil and energy equities, while pressured are long-duration Treasuries, housing, and interest rate-sensitive growth stocks. The event-driven narrative is clear: Strait navigation and the situation in Iran have replaced the Federal Reserve's statements as the primary variable in the short-end yield narrative.
If geopolitical tensions ease or growth concerns outweigh inflation, the 1-month correlation of 0.96 will quickly decline; if supply disruptions persist, the yield's elasticity to oil prices will continue to exceed its elasticity to the dot plot.
Source: Public Information
ABAB AI Insight
The Gulf War in 1990 tied crude oil and US Treasuries into the same trade, with a 3-month correlation reaching 66%. For over 30 years, the two could often be separated: strong demand led to rising oil prices and stable or falling bonds, while recessions saw falling oil prices and rising bonds. The oil price crash in 2014, market tensions in 2019, and the COVID-19 pandemic all saw correlations spike, but rarely did we see triple-digit oil prices alongside a still-tightening federal funds rate. After the Fed's rate hike in September, the policy rate settled in the 3.75% to 4% range, yet the 10-year yield has followed WTI, indicating a temporary shift in pricing power from Volcker Square to the Strait of Hormuz.
The capital pathway is through inflation expectations, not the Fed's reserve channel. Each increase in oil prices synchronously adjusts the breakeven inflation and nominal yield requirements, necessitating higher yields in Treasury auctions to clear the market, while the duration supply under fiscal deficits further raises the curve. Energy traders and macro hedge funds have created a trade combining crude oil and Treasury shorts, while commercial banks and pension funds with long-duration liabilities are forced to shorten duration or buy inflation-protected Treasuries. After the oil market volatility index rises, the options market uses interest rate volatility to hedge commodity volatility, making cross-asset correlation itself a tradable commodity. Money has not flowed into new production but has rapidly repriced between existing crude oil inventories, Strait insurance, and Treasury futures.
Comparable events include the Gulf War in 1990, the Arab Spring in 2011, and the early 2022 Russia-Ukraine conflict's impact on European natural gas and inflation. In 2022, European gas prices determined electricity prices, which in turn influenced core inflation; in this round, US oil prices determine gasoline and diesel prices, which then influence the 10-year yield. The industry is currently in a pricing phase driven by supply shocks, not one where shale production can quickly offset; shale responses require several quarters, while Strait closures are priced weekly. On the stock side, we are entering a high-rate dispersion: energy and banks are positively sensitive to rising yields, while long-duration tech stocks are negatively sensitive.
The structural judgment indicates a transfer of pricing power. The mechanism is that when oil price fluctuations are driven by supply disruptions, the inflation component on the Phillips curve overtakes the growth component, and the bond market no longer views crude oil as a leading indicator of growth but as an exogenous variable in the Fed's reaction function. Whoever controls Strait navigation partially controls US nominal interest rates in the short window. The Fed can still set overnight rates, but the daily fluctuations of the 10-year yield are increasingly influenced by oil tankers and missiles rather than the dot plot. This window will not last forever; once the supply premium recedes, the correlation will separate as it did after 2019; before that separation, crude oil and Treasuries represent two sides of the same macro position.
ABAB News · Law of Cognition
- Supply shocks weld crude oil and Treasuries into the same trade.
- The Strait rewrites the 10-year yield faster than the dot plot.
- The day the correlation peaks is the day of factor overlap.