Previously, the relationship was simple: when oil prices fell, Treasury yields would decrease accordingly. Bank of America claims this pattern has broken. Real rates at the short end of the curve remain high even now, as oil prices have retreated significantly from their peaks.
What Has Changed in the Market Logic
At the start of the year, two-year Treasury yields moved almost in sync with oil prices. The logic was clear: expensive oil drives inflation, inflation forces the Fed to keep rates high, and high rates push up yields. A drop in oil would trigger the reverse process—yields would fall along with it.
Since oil prices peaked, this relationship has stopped working as clearly. Real yields at the front end of the curve—that is, for short-term maturities—have remained elevated even though oil has pulled back noticeably. According to Bank of America, market participants are now reassessing the Fed’s reaction function to inflation itself, rather than simply tracking the price per barrel.
This distinction is crucial for traders. If the market trades oil as the main indicator of future Fed policy, a drop in energy prices would automatically mean softer rate expectations. But if the market is trading the Fed’s determination to tackle inflation directly—as the bank believes is happening now—then a drop in oil alone is no longer a sufficient argument for lower yields.
Why the Bank’s Analysts Expect High Rates to Stay
Bank of America points to two factors supporting its current stance. The first is the resilience of US economic data. As long as employment, consumption, and business activity statistics show no clear signs of cooling, the Fed has no reason to soften its rhetoric just because oil has become cheaper.
The second factor is renewed risks of rising oil prices. The situation in the Middle East remains tense, and any new escalation could quickly send oil prices back up. The market, having already witnessed sharp price swings in recent months, is pricing in the possibility of a repeat scenario.
The combination of these two factors, according to the bank, justifies maintaining bearish positions on short-term Treasury rates and inflation-linked instruments. In simpler terms: analysts advise betting that yields on short-term securities will remain high or rise further, rather than start falling along with oil.
Technical Factors Also Play a Role
Part of the recent rise in real yields is explained by technical reasons—in particular, the attractive carry on inflation-protected bonds, known as TIPS. Carry in this context means the income an investor receives simply for holding a position over time, regardless of changes in the instrument’s price.
When the carry on a particular asset class becomes attractive, it draws in capital and changes market demand structure—regardless of fundamental factors like inflation or economic growth. Bank of America acknowledges that this technical effect partly explains the observed yield movement.
At the same time, the bank emphasizes: even accounting for technical factors, the market still has room for further repricing toward a more hawkish Fed stance on inflation risks. In other words, the current yield level does not look like a ceiling—there is reason to expect further movement in the same direction.
Unusual Picture on the Forward Curve
The bank’s observation about the current market assessment of forward curves deserves special attention. It implies an unusual steepening of the forward real rate curve at the same time as the inflation expectations curve is expected to flatten. Bank of America analysts consider this combination an unlikely scenario.
A steepening of the real rate curve usually means the market is pricing in higher yields at longer horizons relative to shorter ones. Simultaneous flattening of the inflation curve would mean market participants expect inflation to slow in the future. Combining these two moves appears internally contradictory: if inflation expectations are indeed softening, it is hard to explain why real rates at longer maturities should rise more than at the short end.
Instead, the bank expects that sustained US economic growth, combined with renewed risks of rising oil prices, will keep real yields at the front end of the curve elevated. This underpins their recommendation for specific trading positions.
The Bank’s Specific Trading Recommendations
Bank of America has reaffirmed its recommendation to stay short on two-year US rates—in other words, to bet on yields rising rather than falling. Additionally, the bank favors forward real yield flatteners—a strategy that profits when the spread between different parts of the real yield curve narrows.
Also on the recommendation list are inflation swap flatteners on a one- to two-year horizon. The appeal of these positions, according to the bank, is explained by favorable carry and roll dynamics: even in the absence of sharp price moves, the structure of the position itself can generate income simply due to the passage of time and the specifics of the yield curve.
What This Means for the Broader Market
High real yields tighten financial conditions in the economy as a whole. Historically, this creates pressure on rate-sensitive assets—growth stocks, real estate, long-term bonds—and also supports the US dollar against other currencies.
If Bank of America’s view is correct and the market is indeed shifting from trading oil prices to trading the Fed’s resolve, this changes the logic for a wide range of investors. Tracking only energy prices is no longer a reliable indicator of future rate trajectory. Instead, attention should shift to macroeconomic statistics and the regulator’s own communications—these data, according to the bank, will determine yield movements in the coming months much more accurately than the price of a barrel of oil.
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