The national average gas price in Canada was $1.78 a litre on Thursday, up from $1.63 a month ago.Christopher Katsarov/The Canadian Press
The rise in oil prices accelerated Thursday, rattling global markets and pushing borrowing costs to new multiyear highs as inflation concerns mount.
With fighting in the Middle East intensifying on Thursday, the price of a barrel of West Texas Intermediate crude surged past US$100 for the first time since May while Brent crude hit US$108. That’s still below levels reached in the spring, but up more than 40 per cent since early July.
The renewed energy shock has rippled through bond markets in recent weeks, with investors betting that central banks around the world will need to increase interest rates to keep inflation in check.
Both short-term and long-term bond yields have risen sharply. On Thursday, 10-year U.S. Treasury bond yields hit 4.95 per cent – the highest level since 2007. The yield on a similar Government of Canada bond hit 3.95 per cent, a level last seen in 2023.
Through much of the year, the Bank of Canada, U.S. Federal Reserve and other central banks have tried to look through the oil price shock caused by the U.S.-Iran war and the closing of the Strait of Hormuz to tanker traffic. But the latest run-up in the oil prices is testing their patience.
U.S., Canadian bond yields jump as inflation amps up rate-hike bets and oil soars
Bank of Canada Governor Tiff Macklem sounded decidedly hawkish at last week’s interest rate announcement, warning that upside inflation risks owing to high oil prices now outweigh downside economic risks from the Canada-U.S. trade war.
Financial markets are now betting on a one quarter-point rate hike by the BoC by the end of the year – perhaps as early as October – and four rate hikes by the end of 2027.
Likewise, markets are leaning toward a hike next week from the U.S. Federal Reserve, following hawkish remarks from new Fed Chair Kevin Warsh at the Jackson Hole, Wyo., meeting of central bankers last month.
The European Central Bank went ahead with a rate hike on Thursday, and ECB President Christine Lagarde warned that “inflation will be longer lasting than we had anticipated.”
Vikram Rai, senior economist at Toronto-Dominion Bank, said that each central bank is responding to its own domestic data.
“But the oil shock is common to everyone. And the fact this is going to affect inflation and could be feeding into other prices and becoming more entrenched, that’s a common problem, so it’s not a surprise that we’re seeing some common messages,” he said in an interview.
ECB raises interest rates in effort to curb energy-fuelled inflation
Where oil prices go from here will ultimately depend on military developments in the Middle East. Right now, the situation is deteriorating and there is no obvious path to a resolution, said Bhushan Bahree, executive director of crude oil markets at S&P Global Energy.
The U.S. and Iran have ramped up strikes on each other’s tankers in the Strait of Hormuz in recent days. And on Thursday in Yemen, Houthi forces captured a strategic port from government forces, threatening maritime shipping through the Bab al-Mandab Strait at the southern end of the Red Sea.
“We’re on an escalation ladder in both the Gulf and in the Red Sea … so the outlook looks grimmer in terms of oil supply for the very near term,” Mr. Bahree said in an interview.
S&P Global Energy doesn’t see oil prices returning to prewar levels before the end of 2027, and expects them to average between US$80 and US$100 through next year.
The prices paid at the pump could follow their own trajectory higher, as both the war in the Middle East and the war between Russia and Ukraine have knocked out global oil refining capacity, Mr. Bahree said.
Oil prices mixed as investors weigh Middle East escalation, chance of Russia-Ukraine peace deal
The national average gas price in Canada was $1.78 a litre on Thursday, up from $1.63 a month ago. In the United States, the price of a gallon of diesel hit US$6 on Thursday for the first time ever.
The price of oil isn’t the only thing that’s driven long-term bond yields higher in recent months, said Mr. Rai of TD. Investors are also growing increasingly concerned about large fiscal deficits in the United States and other countries and demanding higher compensation for holding long-term debt.
Supply and demand dynamics are also changing in the U.S. Treasury market, which underpins much of the global bond market. A surge in corporate issuance by companies involved in the AI build-out is increasing the overall bond supply, while central banks around the world are reducing their holdings of U.S. Treasuries.
“The official demand has stepped back. Most central banks and the official sector are happy with the level of reserves they have, or see some need to diversify their reserves. And that means that who is buying this debt has shifted from less price-sensitive buyers to more price-sensitive buyers,” Mr. Rai said.
Edgy bond investors unconsoled by Bessent’s big buyback
U.S. Treasury Secretary Scott Bessent has tried to strong-arm yields lower in recent weeks by directly intervening in the market and buying long-term bonds. These efforts appear to have done little to stop the upward march in yields.
Canadian bond yields remain below U.S. yields, as a result of weaker economic growth in Canada, lower inflation and a better fiscal situation in Ottawa compared to Washington. However, long-term yields in Canada have marched up in lockstep with U.S. yields.
“There’s no two ways about it: Canada cannot escape this global tide that we’re seeing in long-term yields,” Doug Porter, chief economist at Bank of Montreal, said in an interview.
“Any hopes that mortgage rates, borrowing costs are going to come down are quickly going out the window here. And the risk clearly is the [Bank of Canada], if they see any signs that inflation is spreading, will hike interest rates, and that will flow through to all kinds of borrowing costs.”