Geopolitical flashpoints in the Middle East have driven oil prices to multi-month peaks. On September 8, reports emerged that US forces destroyed five Iranian crude carriers, prompting Iranian missile strikes on American military positions in the region, reigniting fears of a broader conflict. Beyond the Persian Gulf, instability is spreading to the Red Sea, where Yemen's Houthi movement has announced wide-ranging operations targeting energy infrastructure deep inside Saudi territory. With the Strait of Hormuz already disrupted, Saudi Arabia's reliance on Red Sea ports for oil shipments now faces a new threat of being severed.

In response to these developments, Brent crude surged above $100 per barrel, reaching its highest level since May 25. Meanwhile, US West Texas Intermediate (WTI) spiked to $94.85, breaking past the July 23 peak and setting a fresh high not seen since June 4. Although OPEC agreed last week to maintain its October production quota, market participants remain skeptical that increased output will translate into higher supply, as export blockages have become the more pressing concern.

Strategic reserves and the supply outlook

Data through August 28 shows the US Strategic Petroleum Reserve (SPR) at 286.6 million barrels, a significant drawdown from 415.4 million barrels recorded on February 13. Despite claims of ample domestic supply and a partial equity stake in Venezuelan oil reserves, US crude prices continue to climb in tandem with Middle East tensions. Until the SPR inventory curve shows signs of bottoming out and reversing, a true cyclical peak in US crude prices is unlikely to materialize.

Inflation and monetary policy implications

Higher crude prices are a key driver of US inflation, and with both Brent and WTI strengthening, consumer price index (CPI) and core PCE readings are expected to trend higher in the coming months. Federal Reserve Chair Kevin Warsh remains committed to pushing inflation down to the 2% target, but the recent oil rally raises the odds of a September rate hike. According to the latest CME FedWatch data, the probability of a 25-basis-point hike at both the September and October FOMC meetings exceeds 50%, with the highest probability reaching 58.4%.

Yield curve divergence and dollar dynamics

Elevated oil prices typically translate into higher inflation and, consequently, higher interest rates. As monetary policy tightens, the US dollar index is likely to strengthen over time. However, a closer look at recent market action reveals a divergence: the 10-year Treasury yield has climbed to 4.8%, sitting more than 100 basis points above the upper bound of the federal funds rate at 3.75%, while the dollar index has fallen sharply to its lowest level since May. This breakdown in the usual correlation between yields and the dollar can largely be attributed to Treasury intervention measures. At the G20 meetings, Treasury Secretary Bessent signaled a firm intention to intervene in the yen exchange rate, aiming to push the Japanese currency higher against the dollar. Since the yen is a major component of the dollar index, promoting yen appreciation indirectly pressures the dollar's value. This operation, executed through the Bank of Japan's "sell dollars, buy yen" strategy—funded by selling US Treasuries—explains why bond prices have dropped, yields have risen, and the dollar index has weakened simultaneously. In the longer term, the Fed's tightening bias favors dollar strength over yen appreciation. Once the coordinated US-Japan intervention efforts fade, the dollar index is likely to regain its upward trajectory.

Risk disclosure: Markets carry risk; investment requires caution. The above content represents only the analyst's personal views and does not constitute any operational advice. This report should not be used as the sole reference basis. Analyst opinions may change over time, and updates will not be separately notified.