(Bloomberg) - US Treasuries fell as conflict in the Middle East sent oil prices soaring, stoking fear inflation will accelerate and forcing traders to scale back wagers on the scope of interest-rate cuts.
Rather than sheltering in US government debt as typically happens in times of global market turbulence, bond traders are focused instead on the danger that fighting across the region reignites inflation — potentially dimming the chances of more Federal Reserve easing. US President Donald Trump, who is pushing for regime change in Iran, has said the bombing campaign could continue for weeks.
Shorter-dated bonds led the move, sending the two-year yield six basis points higher to 3.44%, while the rate on 10-year notes rose five basis points to 3.99%. Money markets shifted back the possible timing of the Fed’s next rate cut by two months to September.
“The ‘bond-as-haven’ trade becomes less clean,” if higher oil prices keep price-growth pressures elevated, said Charu Chanana, chief investment strategist at Saxo Markets in Singapore.
European government bonds also fell on Monday and market gauges of inflation surged as the effective closure of the key Strait of Hormuz drove up oil by the most in four years. Euro-denominated one-year one-year inflation swaps jumped as much as 11 basis points, while breakeven rates climbed.
More than geopolitical shocks, higher oil prices can “significantly” lift yields, a Deutsche Bank AG report last week showed. The strategists analyzed the largest geopolitical events of the last 30 years, including Iraq’s invasion of Kuwait in 1990, the Sept. 11 attacks on the World Trade Center, and Russia’s invasion of Ukraine.
A Monday report from Societe Generale SA strategist Manish Kabra, meanwhile, found that five oil supply shocks over the past 50 years had on average weakened the 10-year Treasury note over the following one week, three month and six month timeframes.
Treasury Yields React Mainly to Oil Shocks, Deutsche Bank Say
Investors must also weigh the potential impact on government bond supply, whether in relation to funding an extended military operation, or easing the inflationary burden on households and businesses.
At Fidelity International, portfolio manager Mike Riddell increased a position that will profit if long-dated Treasuries, which are more sensitive to fiscal risk, sell off.
“It’s been a trend for a while for governments around the world to subsidize energy and food prices,” he said. “This trend will only accelerate if the Middle East crisis persists or escalates, which makes long end sovereign bond yields vulnerable at current levels.”
February Rally
The drop in Treasuries comes after US government debt notched big gains last month, as talks between Iran and the US faltered and worries over artificial intelligence mounted. That pushed the 10-year yield back below 4% for the first time since November, while two-year yields fell to the lowest since August 2022.
That move and the focus on inflation helps explain the rise in yields on Monday, said John Taylor, head of European Fixed Income at AllianceBernstein, in a Bloomberg TV interview.
Still, the haven properties of Treasuries may ultimately come back into play, he added.
“The longer this goes on, and if oil prices stay higher for a longer period, people will start to think about the negative economic consequences of that — and that could push Treasury yields lower,” Taylor said.
Iran’s security chief has said the nation has no intention of negotiating with the US. Blasts have been heard across Bahrain, Kuwait, the United Arab Emirates and Qatar as Gulf states intercepted missiles, underscoring how the conflict is spreading beyond the Islamic Republic’s borders.
Dollar Rallies as Oil’s Surge Curbs Bets on Fed Rate Cuts
While money markets pared bets on the chances of three Fed rate cuts this year, they broadly held course for such a reduction by the end of 2027.
Some investors are already buying US Treasuries to act as a safety buffer.
Franklin Templeton’s Andrew Canobi, added to Treasury holdings, mostly via futures. The Melbourne-based money manager said that if the situation persists or even escalates, then “markets will price for a classic downside scenario.”
By Alice Gledhill, Ruth Carson and Masaki Kondo
With assistance from Naomi Tajitsu.
