A Tale of Two Straits: Revisiting Long End Yields

Intro

A month ago I wrote that bond markets are boring right up until they are the only thing that matters, and that yield curves were going on my dashboard permanently. I did not expect the follow-up quite this fast.

The US 10 year recently breached 5%, the highest since 2007. UK, German and French 10 years all moved with it. Japan's 10 year is flirting with 3% and a recent US Treasury buyback could not find enough acceptable bids.

Fiscal worries haven't gone away, but the accelerant this time is $OIL breaching $100 a barrel and diesel surging past $6 in the US for the first time in history.

How We Got Here

Earlier this month the situation in the Middle East shifted dramatically over the course of just a few days. It started when multiple pumping stations on Saudi Arabia's East-West pipeline were struck by drones, reportedly launched from Iraq. That pipeline is built to carry up to 7 million barrels a day to the Red Sea, and was moving around 4 to 5 million, making it the region's most meaningful bypass for the Strait of Hormuz since Iran closed it in March. Saudi Arabia shut the line, and has only just restarted it at a low rate, with full capacity expected in around six weeks.

The next day Houthi forces completed the takeover of Yemen's entire Red Sea coastline and seized Mayyun Island in the middle of the Bab al-Mandab Strait. They now hold the narrowest point on both sides. For now, they have allowed most traffic through, with one exception: Saudi ships are banned. That’s important because Saudi Arabia is the country most reliant on this strait. With Hormuz shut, cargoes heading to Asia (their largest customers) must travel via its Red Sea port, passing through the Bab al-Mandab.

This is monumental for the region and global energy markets because both major chokepoints are now controlled by Iran or its allies, and Saudi Arabia's pipeline was knocked out, not to mention the lengthy detour through the Suez Canal, Strait of Gibraltar and around Africa for that Asia bound fuel.

The Impact On My Portfolio

I hold no oil, gas or defence names. My screening rules them out and that won't change. So none of the obvious trades here are available to me, and honestly I am fine with that, because the obvious trades are also the crowded ones.

The underlying impact from this is the discount rate. Long term rates set what future cash flows are worth today. I described it last month and it has not changed, it has just intensified. When the 10 year moves from 4.5% to 5%, every business whose value sits in cash flows five and ten years out gets marked down, regardless of whether anything about the business changed.

Financing-dependent names get hit hardest. $NIBEB.CO, $TT and Daikin sell equipment usually bought on credit, so a 5% 10 year yield becomes an order book problem, not just a multiple problem.

Utilities and their suppliers, the cable names, ABB, Schneider and Eaton, feel it more slowly through higher rates on new projects. Semis and memory face a valuation problem rather than an operational one, although orders could see a slight slowdown.

The Fed hiked on the 16th of September, its first rise since 2023, and signalled more to come. Oil has had a better week, but the bond yields are rising on central bank risk, not just oil.

What I Have Done

I've shifted the portfolio to be more defensive over the past week or so, adding T-bills via SGOV, gold and Costco, trimming ARM and Trane, and closing Rockwool and Nexans. I've also rotated from AI capex receivers toward the spenders, mainly Google, who fund that capex from cash flow rather than debt.

The two moves balance each other. If AI keeps rallying, more Google means owning more of what the S&P owns. If AI derates, the defensive side cushions the fall. To be clear, at around 5% of my total portfolio it's more of a buffer than a hedge. Because I exclude energy and defence, it mostly narrows a gap I'd otherwise lose in a shock.

Closing Comments

I’ll continue to monitor whether the 10 year holds above 5%, where oil moves next, central bank meetings and the situation in the Middle East.

What do you think the future holds for interest rates, long term yields and oil and gas markets? I’d love to hear your thoughts.

As always, thanks for reading, following and copying. If you found this useful, please check out my portfolio and consider following or copying.