Brent crude surges toward $100 as Middle East attacks reignite supply fears

Brent crude surged toward $100 a barrel Thursday after Houthi forces struck two Saudi tankers in the Red Sea, reigniting supply fears that sent government bond yields across developed markets to multi-year highs.

"The market had been pricing in a resolution in the Strait of Hormuz that simply hasn't materialized," said Mike Bell, head of market strategy at RBC BlueBay Asset Management. "Burying your head in the sand doesn't make geopolitical risk disappear."

Germany's 10-year Bund yield rose 3 basis points to 3.21%, the highest since 2011, while the US 10-year yield climbed to 4.68%, approaching the 4.69% peak hit during the initial phase of the Iran conflict. France's 10-year yield breached 4% for the first time since 2009, and the UK's 10-year gilt yield added 5 basis points to 5.08%.

The cross-asset repricing reflects a fundamental shift in rate expectations. Derivatives markets now fully price two additional 25-basis-point rate hikes from the European Central Bank, while the Federal Reserve is expected to deliver at least two quarter-point increases by March 2027 — a complete reversal from the rate-cut consensus that prevailed before the Middle East conflict escalated.

The attack early Thursday by Yemen's Houthi forces on two Saudi-flagged oil tankers in the Red Sea — vessels the group said violated its recently announced maritime blockade — pushed Brent crude up nearly 3% intraday, bringing it within striking distance of the $100 psychological barrier. The move extends a rally that has seen crude gain more than 30% in just three weeks, with the international benchmark now trading at levels not seen since May, when it briefly touched $126 a barrel.

The transmission from oil to bonds has been unusually direct. Since early July, the 10-year Bund yield has tracked Brent crude almost tick-for-tick as it climbed from the low $70s, reflecting a market that is re-embedding energy-driven inflation risk into long-duration assets. The US one-year inflation swap rate rose to 4.15% Thursday, the highest since January 2025, indicating that investors expect price pressures to persist well beyond any temporary supply shock.

Rate Paths Flip as Energy Costs Bite

The European Central Bank is widely expected to hold its deposit rate at 2.25% at its meeting Thursday, but the policy outlook has shifted dramatically. ING strategist Francesco Pesole said a surprise hike could not be ruled out if the Middle East situation deteriorates further, noting that European natural gas prices — already at their highest since 2023 — are rising faster than crude. Bundesbank President Joachim Nagel has flagged energy prices as the decisive variable for the inflation outlook, urging the ECB to remain vigilant.

In the US, the rate narrative has flipped entirely. Interest-rate derivatives show investors now expect the Federal Reserve to raise rates at least twice by early next year, a stark reversal from the pre-conflict consensus that centered on rate cuts. New Fed Chair Kevin Warsh reinforced that hawkish tilt at his first policy meeting last month, stating the central bank would prioritize its inflation mandate over external political pressure.

Policy Buffers Wear Thin

Unlike earlier phases of the energy shock, policymakers have fewer tools to contain the fallout. The Bank of England warned in its latest Financial Stability Report that strategic petroleum reserve releases and other buffers that helped stabilize markets earlier this year may offer only limited support if the crisis deepens. US crude inventories including the Strategic Petroleum Reserve have fallen to 791 million barrels, the lowest since February 2024, with eight consecutive weekly draws.

The 3-2-1 crack spread — a measure of refinery profit margins — has surged to a record $70 per bundle, equivalent to roughly $23 per barrel, according to HFI Research. That compares with about $27 per bundle in July of last year. Such elevated spreads suggest both crude and refined products are mispriced relative to actual supply conditions, the firm said, adding that Brent could reach $150 a barrel if the Strait of Hormuz remains effectively closed.

"Once cushions thin out, prices have to do more of the adjustment work," said Mehmet Beceren, vice president and senior market strategist at Rosenberg Research. "That means either consumers pay more or demand gets destroyed."

For households, the impact is already visible. US gasoline prices have climbed back above $4 a gallon, and the average 30-year mortgage rate is at its highest in nearly a year as the 30-year Treasury yield extends its longest stretch above 5% since 2003. Consumer sentiment, already near all-time lows, faces further pressure as the summer driving season enters its peak.

This article is for informational purposes only and does not constitute investment advice.