Over the last five years, crude oil and US Treasury yields have moved in tandem. For the most part, the relationship makes sense: both the price of crude oil, which reflects world demand, and US Treasury yields are real-time global growth barometers.
Unlike Treasuries, however, crude oil is derived from a variety of countries with differing production costs as well as economic and political motivations. This leads to temporary pricing distortions. Moreover, OPEC, a cartel of certain oil-exporting countries, and some “cooperating” non-members including Russia, attempt to manage their output to maintain stable prices. In certain situations, both in late 2015 and again this week, crude prices cascaded lower not entirely on demand destruction – which would have denoted weaker global growth – but rather on a supply glut produced by Saudi Arabia with the aim of solidifying and increasing its market share.
During the 2015 oil glut, Treasury yields moved lower, although they didn’t fall to the extent that crude prices would have implied. This suggests that bond buyers at the time understood that the oil price move was temporary and didn’t represent a global growth slowdown.
Last Friday, in response to a production stalemate with Russia, Saudi Arabia signaled its intention to open the spigot again. Benchmark crude prices cascaded as low as $30, the lowest level seen since 2016. This time, perhaps under the coronavirus-induced cloud of uncertainty, risk investors flinched, causing the Dow to plunge 2,000 points and pushing the entire Treasury yield curve below one per cent for the first time in history.
Just like the swoon of 2015, Monday’s oil price plunge was engineered by Saudi Arabia to punish Russia and American producers and to pick up world market share. Like the coronavirus, Saudi Arabia’s production surge is temporary. Treasury investors should not infer that global growth warrants sub-one per cent yields, particularly among longer-dated maturities. We expect Treasury yields to revert to levels consistent with potential GDP growth, over a time period we should measure in months.