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Global bond markets are suffering one of their biggest routs in recent years as inflation fears created by the Middle East conflict have forced traders to dump bets on interest rate cuts in big economies.
UK gilts have suffered their worst week since the country’s 2022 pension fund crisis, pushing the 10-year yield up 0.39 percentage points to 4.62 per cent. The US 10-year Treasury yield is up 0.17 percentage points at 4.13 per cent, the biggest rise since the trade war sell-off in April last year.
Short-term debt has borne the brunt, with two-year German yields rising 0.3 percentage points to 2.31 per cent, heading for the biggest weekly jump since 2023.
This sharp shift higher in rates has been triggered by surging energy prices since the US and Israel attacked Iran, sparking an escalating regional conflict that has all but halted oil and gas flows from the Middle East.
That has fuelled inflation worries and drained hope that central banks will be able to bring down interest rates. Swaps contracts now expect a quarter-point rate increase by the European Central Bank this year, having previously priced the possibility of a further cut.
“This isn’t yet a panic, it’s an unwind of the overly bullish positions that global bond investors had on where interest rates were heading in the near term,” said Mike Riddell, a fund manager at Fidelity International.
The Bloomberg global aggregate bond index, a broad benchmark of sovereign and corporate debt, was on track for its worst week since October 2024.
Bond yields have climbed as investors price in a higher path for inflation due to higher oil and gas prices, with Brent crude marching from $72 a barrel before the conflict began to around $92, and gas prices in Europe rocketing.
Before the conflict began, swaps contracts were fully pricing two quarter-point rate cuts by the Bank of England this year, from the current level of 3.75 per cent. They are now pricing a roughly 50 per cent chance of a single cut.
“The energy point is impactful and the market is much more attuned than it was in 2022,” said Mark Tiernan, global head of macro sales at Deutsche Bank.
The US has fared better than some other big markets, reflecting its status as an energy producer.
US employment data on Friday showing the economy had lost 92,000 jobs in February prompted traders to ascribe a greater probability to two quarter-point cuts from the Federal Reserve this year, underlining the pressure from weak growth to keep central banks easing policy.
But that was still less than the two or three cuts that were expected before the war began.
“The direction of travel is that people who had two cuts priced in are moving to zero,” said Blake Gwinn, head of US rates strategy at RBC Capital Markets, speaking before the jobs data. “The Fed is going to be on hold.”
Fund managers said a deeper hit to economic output that could spur central banks to lower borrowing costs despite higher inflation was not yet on the horizon.
“There’s a natural short-circuit on rates to higher oil prices [when the market begins to focus on growth impact] but we seem not to have reached that level yet,” said Jason Borbora-Sheen, a portfolio manager at Ninety One.
Still, some analysts said the move had gone too far, with investors too quick to anticipate a repeat of the 2022 surge in inflation that followed Russia’s full-scale invasion of Ukraine. They view it as unlikely that central banks would necessarily respond quickly to a war-related surge in inflation and might focus more on the growth impact.
“I don’t see the BoE or ECB responding aggressively with rate hikes to an energy price shock,” said Citigroup’s chief global macro strategist Jim McCormick, saying traders “basically did a rinse and repeat” of the 2022 scenario.
Gilts have been hit the hardest because there were more rate cuts priced in before the conflict than for other economies such as the Eurozone, but also because of the UK’s energy mix, making it particularly vulnerable to a rise in gas prices.
“Gilts are suffering as the UK is seen as too prone to inflation, still,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore.
Additional reporting by Rachel Rees. Data visualisation by Ray Douglas