Bond markets face ‘perfect storm’ as Iran war rattles central banks
Europe’s government bonds are facing a “perfect storm” after fresh inflation fears sparked by the Iran conflict forced the region’s central banks to signal a new course for interest rates on Thursday, causing yields to rise.
The Bank of England left interest rates unchanged at 3.75% on Thursday, while the European Central Bank kept borrowing costs unchanged as the economic impact of rising energy costs weighed on rate-setters.
Yield 10 Years GildingThe benchmark for U.K. government debt rose more than 13 basis points to 4.871% on Thursday, a 52-week high, before easing. The yield on 2-Year Gold bonds, which are generally more sensitive to interest rate decisions, immediately rose 39 basis points, the biggest rise since former Prime Minister Liz Truss’s ‘Mini Budget’ in September 2022. It was last seen 27 basis points higher at 4.378%.
French, German and Italian bonds saw milder selling pressure but yields rose across the continent.
UK 10 Year Gilts.
Market strategists say the unanimous call by the BoE’s nine-member monetary policy committee effectively ends hopes for further rate cuts this year and changes the policy outlook significantly from just two weeks ago.
tactical trading
Ed Hutchings, head of interest rates at Aviva Investors, said the chances of the BoE raising rates in the coming months were increasing.
“With this in mind, from an asset allocation perspective we may begin to see investors tactically adding overweight to gold in the short term, with at least one increase expected later in the year as of today,” Hutchings said. he said.
Matthew Amis, investment director of interest rate management at Aberdeen Investments, described the evolving environment as a “perfect storm” for Europe’s government bond markets.
German 10-Year Bunds.
“Rising energy prices and the Bank of England opening the door to possible interest rate hikes have seen gold prices rise further. German bonds have been relatively calm in this storm but are still pushing 3% due to similar inflation fears,” Amis told CNBC via email.
“Gilds and bonds are priced in a much longer conflict than other markets, with markets focusing on rising inflation without yet focusing on the potential negative impact on growth.”
Meanwhile, the ECB’s next move will likely be a rate hike, according to Simon Dangoor, deputy chief investment officer of fixed income and head of fixed income macro strategies at Goldman Sachs Asset Management.
“The governing council is clearly sensitive to upward inflation risks, but will likely seek to assess potential second-round effects before making a move,” Dangoor said. “An increase in late 2026 is therefore possible, but the ECB is ready to act earlier if the situation worsens.”
‘An economical Dunkirk’
Energy prices continued their rise on Thursday; International benchmark Brent crude oil increased by 3.5% to $111.10, while natural gas prices also traded higher.
Europe sought to diversify its energy mix following the 2022 price shock caused by Russia’s invasion of Ukraine. However, the continent remains a net importer of both oil and gas.
Brent crude oil.
“Yields are recognizing the economic Dunkirk the global economy is facing thanks to the war in Iran,” Chris Beauchamp, chief market analyst at IG, told CNBC via email. “Investors will demand higher borrowing costs from countries across Europe as the outlook worsens. And that’s just with Brent at $110.”
Going forward, if there is a real reduction in tensions soon, government bond markets could start to look attractive, Amis said. In this case, interest rate hike expectations priced for the remainder of 2026 may quickly reverse.
“But with no end in sight for now and central bankers dusting off the ‘things we got wrong in 2022’ playbook, European sovereign markets will remain a volatile place,” Amis added.
But Thursday’s yield rise may be short-lived, said Nicholas Brooks, ICG’s head of economic and investment research. He said oil would need to stay above $100 for a long time before the ECB would consider raising interest rates, and suggested the central bank would likely maintain its benchmark interest rate.
“While persistently high energy prices will likely delay rate cuts by the Fed and BoE, we think both central banks have the opportunity to cut rates in the second half of the year,” Brooks told CNBC via email.
“While there is significant uncertainty about the outlook, our baseline scenario is that energy prices will fall in the coming weeks and months and government bond yields will fall from current levels,” he added.
