With rising tensions comes increased oil prices and Treasury yields…

Three major developments are shaping capital markets this week: renewed escalation in the Middle East, another sharp rise in Treasury yields, and important inflation data ahead of next week’s Federal Reserve meeting. Over the weekend, Iran launched ballistic missiles at U.S. naval forces, including an aircraft carrier and destroyer. American forces responded by striking and sinking several Iranian oil tankers with additional tanker strikes reportedly occurring Tuesday. The escalation comes as Iran remains under increasing pressure from U.S. sanctions and restrictions on its ports, adding further strain to its already weakened economy.

Energy markets have responded accordingly with Brent crude moving back above $100 per barrel, reaching this level for the first time since late July. A conflict initially expected to last days or weeks has now extended into its seventh month with few signs of a near-term resolution. With U.S. midterm elections approaching, investors are increasingly considering the possibility that geopolitical uncertainty, higher energy prices, and related inflationary pressures could persist well into the Fall.

Bond markets too remain under pressure. The Treasury Department announced plans to purchase up to $6 billion of Treasury securities maturing in 10 to 20 years, primarily to improve market liquidity amid the recent selloff but also in an attempt to drive longer yields lower. Investors were underwhelmed by this move. The benchmark 10-year Treasury yield subsequently climbed to 4.85%, its highest level since November 2023. The market’s reaction reinforced an important point: government purchases can influence market conditions at the margin, but investors ultimately determine where long-term interest rates settle.

Attention now turns to inflation with the August PPI data being released Thursday, followed by the CPI release on Friday. Economists expect headline CPI to remain at 3.4% year over year, while core CPI is expected to ease from 2.5% to 2.4%. With oil above $100, long-term yields rising, and employment remaining firm, the Federal Reserve enters next week’s meeting with increasingly limited room for error.