Never mind the bond yields, Bank of America shows where the real threat to the economy lies

By Jules Rimmer

The U.S. economy runs on diesel, and not crude, bond yields or the S&P 500

Setting another record, the US national average price of diesel just crossed $6 a gallon. A year ago it was $3.70.

It's the price of diesel, not rapidly rising U.S. Treasury yields or fading S&P 500 momentum, that poses the real threat to the economy in the U.S. While West Texas and Brent futures have both breached $100 and dominated this week's newsflow, diesel is the energy that fuels shipping, trucking, agriculture, construction and mining.

While the peak in crude after the start of the Russo-Ukrainian war is well above current levels, it's diesel that is setting record highs, surpassing $6 on Friday.

As former Goldman Sachs commodity strategist Jeff Currie pointed out a month ago, "Nobody on planet earth consumes crude oil. Refineries do. Everyone else consumes gasoline and diesel."

Bank of America reiterated that point Friday: "diesel is the key real-economy pressure point."

Diesel is the key real-economy pressure point

The point was reinforced by former Pimco co-chief executive Mohamed El Erian in a posting on X Friday: "While less visible to many than the gasoline we put in our cars, diesel is a critical economic input. It fuels the trucks, cargo trains, and farm equipment that produce/transport much of what we consume."

For a change, this week's Flow Show strategy note from Bank of America is lead-authored by exchange-traded fund strategist Jared Woodward rather than Michael Hartnett. The penchant for punning titles hasn't diminished, however. "Those yields might not hurt yet, but diesel."

Woodward points out that long bond yields BX:TMUBMUSD30Y approaching 5.3%, the highest since 2007, are greeted by yawns from stock and government bond traders but these blasé markets, added to what he calls "bravado policy" from Treasury Secretary Scott Bessent and Fed Chair Kevin Warsh, are the perfect recipe for autumn volatility.

Other Bank of America strategists this week have referred to a surprising lack of market stress and anxiety, despite warning signals from bond markets. Hartnett has often reminded investors of late that markets stop panicking when the Fed starts panicking. What he means by this, is that markets will feel more confident if the Fed tightens monetary policy to shore up its inflation-fighting credentials.

Woodward's piece highlights the recent phenomenon in which holding bonds no longer offers the diversification benefits it did. In recent weeks, bonds have incurred losses even when the stock market showed signs of weakness. Allocators may require higher yields before moving wholesale into bonds, regardless of what measures the Treasury Department employs in the market to cap yields.

True quality (FCF) outperforms other factors

One stockpicking trend that Woodward focuses on is a flight to quality, those stocks that have high free-cash-flow yields without excessive debt.

The FCF yield on the S&P 500 SPX is at record lows at present, a function of the immense investment in the buildout of AI infrastructure, but the VictoryShares Free Cash Flow ETF VFLO that invests in high FCF stocks is up 37% year-to-date. In a stagflation year like 2022, Woodward notes, FCF stocks rose 9% while the broader index lost 18%.

-Jules Rimmer

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