Investors reassessing the potential for deeper economic pain from the war in Iran are selling assets across the globe, from government bonds to stocks and gold, reigniting fears that markets may become vulnerable to a bigger dislocation.
Oil prices jumped to as high as $119 a barrel on Thursday as Iran attacked energy facilities across the Middle East following Israel’s strike on its South Pars gas field in the biggest escalation of the conflict yet. Oil prices dropped in the New York afternoon, leaving Brent around $108, following comments by Israeli Prime Minister Benjamin Netanyahu and a U.S. move to allow the sale of some Russian oil. U.S. stocks finished the day modestly lower, buoyed in part by the late-day retreat in crude prices.
Sharp declines Thursday in many global stock indexes were exacerbated by hawkish signalling from the U.S. Federal Reserve, as all G7 central banks met within less than 24 hours in a rare coincidence.
There are signs that the supply disruption arising from the U.S.-Israeli war on Iran was hitting international markets particularly hard. On Wednesday, the spread between Brent crude and U.S. West Texas Intermediate crude hit $12.05 per barrel, its widest since March 2015.
The European Central Bank may need to begin discussing rate hikes in April and possibly tighten in June, unless the conflict is quickly resolved, three sources said.
Traders, increasingly worried about inflation risks, no longer see the Fed cutting rates this year. They further boosted rate hike bets in Europe, expected to be more responsive to higher energy prices after a 2022 energy crisis sent inflation soaring.
They now price a roughly 60% chance of an ECB rate hike in April.
Against this backdrop, government bond yields from Britain to Italy and the United States surged again for much of Thursday, though U.S. yields gave back much of their gains in afternoon trading in New York.
Britain’s two-year yields, sensitive to rate expectations, jumped over 30 basis points (bps). They were set for their biggest daily increase since former Prime Minister Liz Truss’ failed 2022 economic plan.
The selloff across markets was broad, in a sign that investors are growing more worried about inflation and growth risks from the conflict, which analysts say they have priced in as short-lived so far.
European stocks tumbled to their lowest level since December.
“It felt as though markets were positioned for a relatively brief price shock rather than an extended crisis,” said Schroders’ head of global economics, David Rees.
“If we do get prices going higher and staying higher for longer, then it makes sense that the broader washout in markets would be more painful.”
Gold, which had surged earlier this year, fell 4.4%. Analysts say well-performing trades have been tapped to make up for losses elsewhere.
Nick Kennedy, a currency strategist at Lloyds, noted the latest attacks had brought significant energy infrastructure into the conflict for the first time.
“That is a clear escalation and you don’t know where that ends up, so markets are right to be a bit more cautious, as it has crossed the Rubicon.”
RATE HIKE BETS JUMP
The dollar fell 1% against the yen and 0.7% against the euro.
Support for the dollar is “being tempered by the fact that other major central banks are priced to hike this year, whereas the Fed is not,” said Uto Shinohara, senior investment strategist at Mesirow Currency Management.
While traders folded on their bets for Fed cuts following Wednesday’s meeting, they are pricing in a high chance of rate hikes from the BoE by year-end, a huge turnaround from pre-war bets on a rate cut in March. The BoE also vindicated traders’ hawkish bets on Thursday, when policymakers voted unanimously to keep rates on hold, and some raised the prospect of raising rates.
“I think the Bank of England certainly came off a little bit hawkish with its concerns about inflation,” said Zachary Griffiths, head of investment-grade macro strategy at CreditSights in Charlotte, North Carolina. “We’re more concerned about the demand destruction and growth implications of what’s going on in the Middle East. And I think maybe even within today, you’re seeing those two factors in conflict, and it’s hard to say which one sort of wins out on a minute-by-minute basis.”
Traders fully price in two ECB rate hikes and a strong chance of a third by December.
Euro-area and U.S. short-dated bond yields surged about 10 bps.
RISK ASSETS UNDERESTIMATING CONFLICT
Even after Thursday’s moves, the stocks selloff remains modest, analysts said, leaving markets exposed to bigger moves.
The S&P 500 stock index, down sharply earlier in the session, closed lower by 0.3%, leaving it down 3.7% for the year and 5.4% below its recent high.
“The IEA called the (energy) shock the largest disruption in history and yet global equity markets are down less than 5%,” said Kevin Thozet, investment committee member at Carmignac.
“There’s maybe an underestimation across markets on the risk that this supply shock morphs into a demand shock.”
Two-year swap rates, off which mortgages are priced, also jumped by the most since 2022 in Britain, signalling potential pain for households.
Higher rates and lower growth could also fuel jitters about private credit.
More broadly, credit markets sold off, with the iTraxx Europe Crossover index measuring the cost of insuring against junk debt defaults at its highest since May 2025.
(Reporting by Yoruk Bahceli and Samuel Indyk)
