Global bond market sentiment has dramatically shifted from disinflation hopes to fears of renewed monetary tightening in just three weeks.
The direct trigger for this reversal was the energy shock following the start of the Iran war on February 28. Brent crude, which was trading around $70 before the conflict, soared to nearly $108 by March 20, a staggering 54% increase. This surge in energy costs immediately reignited concerns about headline inflation and shifted expectations for central bank policies.
This new reality was swiftly reflected in government bond markets. The U.S. 10-year Treasury yield climbed from 3.97% to 4.26%. In the UK, the 10-year gilt yield spiked from 4.39% to an intraday high of 5.04%, and Germany's 10-year bund yield rose to 2.95%, approaching its 2023 peak. This wasn't just a minor adjustment; it was a fundamental repricing of risk.
The causal chain is quite clear. First, the geopolitical conflict created a direct and immediate shock to energy supply chains, particularly through the Strait of Hormuz. Second, this energy price surge forced markets to abandon the prevailing disinflation narrative. Expectations for interest rate cuts, which had been building, quickly evaporated and were replaced by a 'higher for longer' scenario, with some even pricing in the possibility of further hikes. Third, major central banks validated this shift. The Bank of England, European Central Bank, and the U.S. Federal Reserve all held their policy rates steady in March and explicitly warned about the inflationary risks stemming from the conflict.
This pivot was made easier by the pre-existing conditions. While inflation had been cooling before the war, central banks remained wary of sticky services and wage inflation. Their policy stance was already data-dependent and cautious. Therefore, when the external energy shock arrived, they had little hesitation in reverting to a more hawkish tone, effectively shelving any near-term plans for rate cuts.
In summary, the geopolitical shock has reshaped the economic landscape. The focus has moved from when central banks will cut rates to if they will have to tighten further. While it is an overstatement to say that multiple rate hikes are fully priced in, the possibility is now firmly on the table. The key factor determining the future path of monetary policy will be the persistence of these elevated energy prices.
- Headline Inflation: A measure of the total inflation within an economy, including commodities such as food and energy prices, which tend to be more volatile.
- Gilt: A bond issued by the UK government. It is the UK equivalent of a U.S. Treasury bond.
- Hawkish: A term used to describe a monetary policy stance that favors higher interest rates to control inflation.