Yields on government debt across European countries and the United States have been rising since the start of the Iran war.
Investors are demanding higher yields as confidence in the global economy has cratered due to the severe negative impact of the conflict on energy markets, supply chains and Middle Eastern infrastructure.
The 2-year notes, sensitive to near-term rate expectations, have risen faster than their 10-year counterparts in a classic bear-flattening move, while longer-dated yields reflect worries over the economic drag caused by more expensive energy.
Speaking to Euronews, BCA Research’s Chief Fixed Income Strategist, Robert Timper, explained that “the aggressive bear flattening of yield curves reflects a hawkish monetary policy repricing in response to inflation fears stemming from the Iran war”.
“The front-end [2-year yields] is more sensitive to changes in monetary policy and has therefore risen more than the long-end [10-year yields] in response to investors’ anticipation of more hawkish central bank policy,” Timper added.
Historically, this specific curve behaviour often precedes an inverted yield curve, which is a well-recognised indicator of a potential economic recession.
European bonds bear the brunt of the sell-off
The repricing has been most pronounced in Europe, with the UK bond market feeling the biggest pressure.
Since the start of the conflict, the 10-year UK gilt yield has risen from 4.2% to a high of over 5% while the 2-year note yield jumped from 3.5% to a peak of 4.6%.
Timper explained to Euronews that past inflation experience has proved decisive, stating that “rate hikes in the UK are more likely than elsewhere because inflation has been more elevated than elsewhere, and the risk of inflation expectations unanchoring is therefore higher.”
On Wednesday, AJ Bell’s investment director Russ Mould highlighted the UK-specific implications in a detailed press release, noting that the 10-year gilt yield is hovering near 5% for only the third time since 2008 while the 2-year gilt yield comfortably exceeds the Bank of England base rate.
Mould also explained that the gap between the 10-year gilt yield and the FTSE 100 dividend yield has widened to more than one-and-a-half percentage points, making UK equities relatively less attractive.
Elsewhere in Europe, bond yields experienced similar surges.
Germany’s 10-year bund yield increased from 2.65% to around 3%, nearing 15-year highs, while the 2-year note yield climbed from roughly 2% to 2.65%.
In France, the 10-year OAT yield jumped from 3.2% to above 3.7%, approaching 17-year peaks, while the 2-year note yield has risen from 2.1% to over 2.8%.
As for Italy, the 10-year BTP yield was at around 3.3% before the Iran war and has now surpassed 3.9%, approaching two-year highs, while the 2-year note yield has increased from roughly 2.15% to 3%.
In every single one of these bond markets, the yield on the 2-year notes has risen faster than their 10-year counterparts.
The 30 and 20-year bond yields are also all trading higher which denotes deteriorating confidence in the long-term growth prospect of the respective European economies.
US Treasuries face comparable headwinds
Across the Atlantic, US Treasuries have followed a similar trajectory, though the sell-off has been less severe than in the UK for example.
The 10-year note yield has risen from around 3.9% to a peak of 4.4%, reached on Monday, and is currently trading at 4.37%.
Meanwhile, the 2-year note yield increased from 3.35% to a high of over 4%, and it is hovering 3.9% at the time of writing.
The yields on both notes have hit an 8-month high.
Timper’s analysis places US bond performance close to that of the euro area, reflecting broadly comparable inflation histories and policy outlooks. There is scant evidence of investors fleeing European bonds for US Treasuries as a safe-haven trade.
Speaking to Euronews, Timper explained that such shifting flows would be more visible in currency markets as the US dollar benefits from being the predominant denominator for energy exports.
For now the message from bond markets on either side of the Atlantic is consistent, the Middle East conflict has rewritten the near-term outlook for inflation, monetary policy and borrowing costs.