Lower oil prices will not - as many believe - spark a sell-off in US government bonds as money from oil exporters that's been parked in Treasuries stops flowing, according to London-based research consultancy Capital Economics.
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A lower oil price did however increase the chances of the Federal Reserve tightening policy more aggressively than most expect, chief markets economist John HIggins said in a note published on Tuesday.
Oil has plunged about $US4 a barrel in the past two days, with Brent crude falling to a new five-year low low of $US65.71 a barrel on Tuesday afternoon. It's down more than 40 per cent since this year's high in mid-June.
Over the past years, when the oil price sat comfortably above $US100 a barrel, many oil exporting countries poured their surplus savings into high-quality and low-risk financial assets, such as US Treasuries. This "petrodollar recyling" was considered one of the reasons behind the US bond market's rally.
But the accumulation of US Treasuries by net oil-exporting countries since the trough of the oil price in late-2008 had been fairly small in comparison to the accumulation by the two largest net oil-importing countries after the US itself, namely China and Japan, Mr Higgins said.
Because of this, there had been "little detrimental impact on the demand for US government bonds."
However, 10-year bond yields should begin to rise over the next few years, climbing to 4 per cent by the end of 2016 from 2.3 per cent today, Capital Economic said - but not because of a repatriation of petrodollars.
While the fall in oil price is expected to lower inflation in the near-term - which is likely to keep a lid on bond yields - "it will also boost growth significantly" and this will add to the prospects for long-term inflation.
The US Federal Reserve will need to tighten monetary policy to combat this, and as a result, bond yields will rise.
"Our long-held view has been that the Fed will tighten monetary policy sooner and more aggressively than most expect as a tightening labour market - the unemployment rate has already fallen close to its natural level - begins to put upward pressure on wage and core inflation.
"This view has also been central to our view that the 10-year Treasury yield will rise sharply over the next few years.
"The more the price of oil falls, the more confidence we have in these forecasts."
