The global bond market limped to the end of a bruising week on Friday, as growing evidence of economic damage from the Iran war prompted investors to assume interest rates will rise faster than expected and growth will suffer.
U.S. Treasury yields hit their highest in around a year as traders anticipated the Federal Reserve may need to hike rates to rein in inflationary pressures stemming from Iran war-fueled energy shocks.
U.K. gilt yields surged again, hitting their highest in decades, as pressure mounts on Prime Minister Keir Starmer to resign over his Labour Party’s hefty losses in local elections, and as challengers emerge. Yields across the euro zone jumped, while Japanese bond yields hit record highs.
Italian 10-year bonds were among the worst performers, with yields up 11 basis points to around 3.89 per cent, bringing the rise for the week to 16 bps, while benchmark German Bund yields rose almost 7 bps to around 3.12 per cent, up 11 bps this week.
Inflation data this week has shown consumers and businesses are starting to see big increases in price pressures as a result of the war, which has pushed up the price of crude oil by more than 50 per cent.
“We see a reset of this global bond risk premium because the market is just realizing we’re living in a much more volatile inflation climate,” Daniel von Ahlen, senior macro strategist at GlobalData TS Lombard, said.
U.S. inflation rises to 3.8% in April as Iran war lifts energy prices
Two-year yields, which are the most sensitive to changes in expectations for inflation and interest rates, have risen most sharply this week, but yields on longer-dated bonds have started to increase as well, reflecting investors’ concern about the longer-running impact from a price shock.
“Global yields have probably come to the point where they are high enough to hurt sentiment. Between a resilient global economy powered by AI build-out and elevated energy prices, central banks are probably more worried about inflation,” DBS senior rates strategist Eugene Leow said.
Money markets show traders see a 60-per-cent chance of the Fed delivering a rate hike this year. Before the war, at least two cuts had been priced in.
The rates market also shows that just four out of 24 of the world’s most influential central banks have any meaningful chance of delivering a rate cut this year, with the vast majority tilted in favour of hikes, according to LSEG data.
“It’s not just inflation, but also higher deficits that should be the focus,” Jefferies strategist Mohit Kumar said.
“We are likely to see a number of support measures for fuel subsidies announced in the coming months.”
Kumar said he anticipated a steepening bias in government bond curves, referring to a market dynamic in which longer-dated bond yields rise more quickly than those of shorter maturities.
Ten-year yields across the G7 nations have risen by an average of 17 bps this week, compared with an average rise of 12 bps for two-year G7 debt yields. Benchmark 10-year Treasury notes were last yielding 4.54 per cent, up 8 bps on the day and around their highest since last June.
Benchmark 10-year gilts, which have risen by over 20 bps this week, were up another 15 bps at 5.14 per cent on Friday, while 10-year Japanese yields closed up 7 bps at 2.7 per cent.