Crude jump speeds up bond sell-off

Oil prices jumped to their highest level so far this year, nearing $70 a barrel and accelerating a sell-off in global debt markets.

Crude approached $70 a barrel after US oil inventories posted a weekly fall for the first time in four months and production from conflict-hit Libya suffered further falls.

Brent, the international benchmark, is now up more than 50 per cent since bottoming near $45 a barrel in January, boosted by stronger demand, near-record hedge fund buying and a slide in the US dollar.

It is now at its highest level since Opec's historic decision in November to let prices fall, in a bid to claw back market share by squeezing higher-cost producers.

The rise in oil prices has encouraged expectations of higher long-term inflation rates - one factor driving the sell-off in bonds.

The rout threatens to halt a long-running rally in government bonds that has been fuelled in part by the extraordinary measures taken by central banks in the wake of the financial crisis.

Prices for benchmark 10-year German Bunds, considered a proxy for the wider European market, fell on Wednesday, sending yields, which move inversely to prices, to their highest point so far this year.

The US bond market suffered collateral damage, with the 10-year US Treasury yield up 4 basis points to a two-month high of 2.22 per cent.

The sell-off came as Federal Reserve Chair Janet Yellen warned that bond yields could jump sharply higher when the US central bank raises interest rates. The Fed is expected to wait for a rise in annual inflation above its target of 2 per cent before it starts tightening monetary policy. If the oil price rise continues, that target will be reached more quickly.

Also on Wednesday the US stock market slipped by as much as 0.6 per cent to a two-week low, with concerns over equity prices fuelled by Ms Yellen saying at a Washington forum that valuations "are quite high"

The sharp rise in the oil price over the past month could threaten Opec's strategy of squeezing out higher-cost producers, traders and analysts say. Some of the largest US shale producers, which have slashed costs and improved efficiency, have said they can increase production if prices remain at their current level. That threatens to add more oil to the market, again putting downward pressure on prices.

"The factors supporting the upward momentum cannot be underestimated and could drive prices even higher in the near future," said Tamas Varga at PVM, an oil brokerage.

Higher bond yields could also be a sign markets believe that eurozone quantitative easing - which was designed to avert a deflationary slump in Europe - is starting to work. Earlier this year, markets were still showing serious concern about the risk of deflation.

QE in Europe sent share prices soaring and government borrowing costs to historic lows with yields on many government bonds falling into negative territory. But the recent bond sell-off has thrown that process into reverse.

Just two weeks ago, yields on German 10-year bonds dropped to a record low of 0.05 per cent while shorter-term debt across a wide swath of the eurozone government bond market traded below zero. In the US yields on 10-year debt are now up almost half a percentage point since the April low.

Steven Major, global head of fixed income research at HSBC, said the bond sell-off was driven by investor fatigue, as well as burgeoning signs of inflation and higher issuance of eurozone bonds. "It's a form of indigestion," he said. "There just isn't the same appetite for bonds at ultra-low yields."

Elaine Moore, Neil Hume and David Sheppard in London, and Robin Wigglesworth in New York.

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