Bond markets are under pressure as the war in the Middle East raises inflation concerns

Global bonds are reeling from heavy monthly losses as the war economy grows

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  • Prolonged conflicts change the market’s focus to bearish growth
  • Central banks walk a tightrope; UK long-term interest rates are expected to rise by around 100 bps in March
  • Germany is up 69bps, US is up 50bps
SINGAPORE/LONDON/NEW YORK, March 30 (Reuters) – Global government bonds are headed for their biggest monthly decline in years as investors raise the prospect that a protracted conflict in the Middle East will push up inflation and dampen economic growth.
The US-Israel war against Iran, now entering its second month, has caused a sharp rise in oil and gas prices as markets reel from the worst disruption to energy supplies in history. That has raised expectations of higher prices across the economy – increasing bond yields in the major fixed income markets in the US, Europe, Japan and elsewhere as investors sell those instruments.

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The two-year US Treasury yield – which moves in a different direction from its price and reflects expectations of a monthly Federal Reserve interest rate increase of 45 points, the largest since October 2024. Monday, was down 8.6 bps at 3.83%.

The move reflects investors dismissing earlier sentiments about the Fed tapering this year. US interest rate futures don’t see any further rate cuts by the US central bank this year – and instead they have started to signal a small increase in the fed funds rate.

The annual 10-year Treasury yield rose about 40 bps on the month to about 4.39%, although it was trading lower on Monday.

Japanese bond yields rose to a three-decade high on Monday, up 13 bps on the month.

Clearly, the Treasury rose from last week’s losses on Monday, in what investors said could be a sign that some are starting to worry that the impact of the war on growth may outweigh the impact on inflation, which has dominated discussions since the beginning of the conflict.

“The Fed will probably have a tough time raising the fed funds rate just based on slower growth,” said Jim Barnes, director of fixed income at the Bryn Mawr Trust in Berwyn, Pennsylvania. “And they will also have a very difficult time reducing interest rates. We have inflation at 3% and most expectations are for it to be higher not lower.”

Oil prices remain firmly above $100 a barrel, and are set to end March with their biggest gains since at least 1988.

BIG CONGRATULATIONS ULAHA

The move in bond prices in Europe has been a surprise, with markets already seeing two or three interest rate hikes from the European Central Bank and the Bank of England this year. In the BoE’s case, that’s a big change from expectations of two rate cuts before the war.

Britain’s two-year yield rose 98 basis points this month, the biggest since the 2022 market turmoil under interim prime minister Liz Truss, while the 10-year yield was up 70 bps.

Germany’s two-year monthly yield rose 61 bps and its 10-year yield rose nearly 40 bps, hitting a 15-year high of 3.13% last week. ,

Measures in Italy, which investors see as more exposed to energy shocks than other eurozone peers, are more or less the same as Britain – its two-year yield is up 85 bps and 10-year 78 bps per month. ,

But eurozone bond yields were also lower on Monday, likely caught in a similar shift in the narrative towards growth concerns.

“It is a very difficult situation for the ECB and every central bank in this deflationary situation to balance the risk of inflation… and not damage the economy even more by raising rates too much,” Berenberg chief economist Felix Schmidt said.

Bond markets are under pressure as the war in the Middle East raises inflation concerns

CHINA IS COMPLETE

In the Asia-Pacific region, Australia’s three-year bond yield rose 50 bps this month, the most in 17 months, although it had fallen on Monday to 4.72%.

Japan’s 25-bps monthly increase in its 10-year yield would mark the strongest advance since December.

Chinese government bonds are holding up well, as investors bet the world’s second-largest economy will be better insulated from oil discoveries because of its neutral abundance, green energy regulation and low cost.

China’s two-year bond yields fell more than 11 bps, set for the biggest monthly fall since December 2024.

Reporting by Rae Wee from Singapore, Alun John from London, and Gertrude Chavez-Dreyfuss from New York; Additional reporting by Samuel Shen in Shanghai and Sophie Kiderlin in London; Edited by Kevin Buckland, Dhara Ranasinghe, Andrew Heavens and David Gaffen

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