Oil surge and US bond turmoil put Pakistan under pressure

Oil surge and US bond turmoil put Pakistan under pressure

Heavy investment in artificial intelligence infrastructure and a sharp rise in oil prices since the Iran war began have shaken US bond markets, pushing long-term borrowing costs to their highest levels in nearly two decades. The Trump administration has tried to contain yields through increased buybacks of long-term debt and coordinated efforts with Japan to support the yen, but these measures have failed to reverse the upward trend.

Brent crude, which traded at around $70 a barrel in early July, has climbed above $110. Meanwhile, the Federal Reserve, European Central Bank and Bank of Japan have all raised interest rates this summer. Higher US bond yields influence borrowing costs worldwide, although the impact varies across economies. Countries with close financial ties to the United States or weak external accounts face greater pressure, placing Pakistan among the more vulnerable economies.

However, the market turmoil does not necessarily signal a global recession triggered by the Gulf conflict. China, South Korea and Taiwan recorded a combined trade surplus of $200 billion in September alone. Yet, instead of directing much of this surplus into US bonds, investors have increasingly favoured American equities. This shift, known as de-reservification, involves governments and investors moving dollar holdings away from traditional foreign exchange reserves towards pension funds, banks and other investment vehicles.

The changing investment pattern suggests that returns are increasingly influencing the dollar’s role in Asia, rather than its traditional appeal as a safe asset. For Pakistan, the bigger concern is the rise in energy costs. The country imports roughly 90% of its energy, leaving domestic petrol and diesel prices, electricity tariffs, transport expenses and food costs highly exposed to fluctuations in international oil markets.

Recent developments illustrate how quickly these pressures reach consumers. Pakistan raised domestic fuel prices by around 20% in early March as the conflict intensified. Headline inflation subsequently increased from 7.3% in March to 10.9% in April and 11.1% in August, with rising energy, transport and food costs contributing to the increase.

In response to mounting inflationary pressure, the State Bank of Pakistan raised its policy rate by 100 basis points to 11.5% in April and maintained that level at its September meeting. With oil prices elevated and global borrowing costs under pressure, Pakistan faces the challenge of containing inflation while managing the broader economic consequences of expensive energy and tighter financial conditions.