Global government bonds are headed for their biggest monthly fall in years as investors increasingly factor in the chances that a prolonged war in the Middle East will cause inflation to spike and undermine economic growth.
The U.S.-Israel war on Iran, now entering its second month, has caused a dramatic spike in oil and gas prices as markets reel from the worst ever disruption to energy supplies in history. That has raised expectations for higher prices throughout the economy – boosting bond yields in major fixed income markets in the U.S., Europe, Japan and elsewhere as investors sell those instruments.
The U.S. Treasury two-year yield – which moves inversely to its price and reflects Federal Reserve interest-rate expectations – was set for a monthly rise of 45 basis points, the largest since October 2024. Monday, it was down 8.6 bps at a yield of 3.83%.
The move reflects investors scrapping earlier assumptions on Fed easing this year. U.S. rate futures no longer see the U.S. central bank lowering rates this year – and instead have started to factor in a small rise in the benchmark fed funds rate.
The benchmark 10-year Treasury yield is up nearly 40 bps on the month to around 4.39%, though it traded lower on Monday.
Japanese bond yields surged to three-decade highs on Monday, and were up 13 bps on the month.
Notably, Treasuries rebounded from the previous week’s losses on Monday, in what investors said could be a sign that some are starting to worry that the war’s effect on growth might outweigh the effect on inflation, which has dominated the discussion since the outset of the conflict.
“The Fed is probably going to have a difficult time raising the fed funds rate just based on the focus on slowing growth,” said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania. “And they’re also going to have a very difficult time lowering interest rates. We have inflation at 3% and many expectations are for it to go higher not lower.”
Oil prices remain firmly above $100 per barrel, and are set to end March with their biggest percentage gain since at least 1988.
BIGGER MOVES IN EUROPE
Bond price moves in Europe have been more dramatic, and markets are now pricing in two or three interest-rate hikes from the European Central Bank and Bank of England this year. In the BoE’s case, that’s a dramatic swing from expectations for two rate cuts prior to the war.
Britain’s two-year yield has risen 98 basis points this month, its most since 2022’s market turmoil during Liz Truss’ short-lived premiership, while the 10-year yield was up 70 bps.
Germany’s two-year yield on the month has jumped 61 bps and its 10-year yield is up nearly 40 bps, hitting a 15-year high of 3.13% last week.
Moves in Italy, which investors see as more exposed to the energy shock than other euro zone peers, are almost comparable with Britain – its two-year yield is up 85 bps and its 10-year 78 bps on the month.
But euro zone bond yields were also a touch lower on Monday, potentially caught up in the same shift in narrative towards growth worries.
“It’s a very difficult situation for the ECB and every central bank in this stagflation scenario to balance the risk of inflation … and not hurting the economy even more by raising rates too much,” Berenberg senior economist Felix Schmidt said.
CHINA OUTPERFORMS
In the Asia-Pacific region, Australia’s three-year bond yield was up about 50 bps this month, the most in 17 months, despite easing on Monday to around 4.72%.
Japan’s 25-bps monthly rise in its 10-year yield would mark the steepest advance since December.
Chinese government bonds have held up relatively well, as investors bet the world’s second-largest economy will be better insulated from the oil shock due to its ample crude stockpiles, dominance in green energy and subdued inflation.
Chinese two-year bond yields have fallen more than 11 bps, set for their largest monthly fall since December 2024.
(Reporting by Rae Wee)
