Inflation Fears and Oil Surge Rattle Markets

As markets anxiously await the outcome of the current FOMC meeting, Treasury yields notched new 19-year highs in trading Tuesday. The closely watched 10-year surpassed 5.0% Tuesday morning in a high not seen since July 2007. Even the 30-year Treasury yield rose sharply, hitting 5.4%, its highest since June 2007.

In addition to worries over persistent, rising core inflation (one of the Fed's preferred inflation measurements), skyrocketing oil prices and shortages create further pressure on Treasuries. Currently, the rolling one-month correlation between the 10-year Treasury yield and front-month WTI (West Texas Intermediate) crude sits at 0.96 per BMO Capital Markets analysis.

Bond yields and oil prices have moved in tandem for much of this year as investors position for the longer-term inflationary impact of higher oil prices. And with major oil execs sounding the alarm on global supply cache shortages and strategic reserves depletion that help to temporarily soften spiking oil prices for consumers, these pricing pressures are likely to continue in the near-term. Saudi Arabia announced the closure of its East-West pipeline that bypassed the Strait of Hormuz after it came under attack late last week, and cancelled some shipments to Europe, reported Reuters .

"Normally, the relationship isn't as clean as it is now, but the geopolitical drivers behind the price of oil and global inflation are so prominent that the normally modest correlation has become much tighter," Steve Sosnick, Chief Strategist, Interactive Brokers told CNBC . "As long as oil prices remain firm and continue to drift higher, this will add pressure to interest rates."

Where the ETF Flows Are Going, and Where They're Not

As macro uncertainty continues and inflation persists, bonds and oil/energy will be categories to keep a weather eye towards and could see renewed ETF investor attention. Currently, investors are seizing the opportunity in longer-term bonds, with $9.7 billion flowing into the iShares 20+ Year Treasury Bond ETF (TLT) in the last three months though the fund is only up $3.4 billion net YTD according to FactSet data. It will be a category likely to see action in the wake of the FOMC rate decision. As bond yields climb, prices fall as they move inverse to each other, and should yields climb higher, investors may choose to scoop up longer duration bonds at depreciated prices for future gains. However, an exodus is more likely until the path of rate hikes becomes more certain.

Meanwhile, short- and ultra-short bonds remain a popular defensive play across the board this year. Investors can't get enough of the iShares 0-3 Month Treasury Bond ETF (SGOV) this year, with the fund attracting over $40 billion in net flows thus far. The PGIM Ultra Short Bond ETF (PULS) attracted $5.7 billion net YTD while the Vanguard Short-Term Bond ETF (BSV) has gathered $5.2 billion net this year. Investors appear to be eschewing the short end of the curve right now in favor of the pricing opportunity in longer duration bonds, but short- and ultra-short bonds are an increasingly popular hedge for investors grappling with an environment of ongoing volatility and macro uncertainty.