Global bond markets faced renewed selling pressure Wednesday as rising oil prices linked to the U.S.-Iran war led traders to bet that central banks may have to scrap planned rate cuts and instead consider tightening policy.
Short-dated bond yields – which are sensitive to interest-rate expectations – shot higher as bond prices tumbled in the eurozone and Britain. Yields also rose in the United States.
"What the rates markets is saying is that this war leads to a prolonged rise in oil, and the path that central banks are on will have to shift to a more hawkish one," said Seema Shah, chief global strategist at Principal Asset Management.
Energy prices have risen dramatically this week as flows through the vital Strait of Hormuz have slowed to a halt and Iran has hit its neighbors' exporting infrastructure.
U.S. President Donald Trump's statement that the war was "very complete" helped cool prices Tuesday, but they were volatile Wednesday and last up around 2% following reports that vessels were struck by projectiles in the key Strait of Hormuz.
Prices neared $120 a barrel Monday and last traded at around $90, up roughly 25% since the start of the war.
Germany's two-year bond yield rose as much as 8 basis points, Britain's and Italy's jumped more than 12 basis points, while those in the United States climbed 3 basis points. Longer-dated bond yields also rose.
ECB official eyes hikes
In the eurozone, comments to Bloomberg from European Central Bank member Peter Kazimir helped spark a renewed sell-off in bonds after he said the war risked pushing the ECB to raise rates sooner than previously thought.
Money market traders see a roughly 80% chance of an increase by July and fully priced in an increase by September. Traders had previously seen a chance of rate cuts this year before the war broke out.
Germany's two-year bond yield remained below the 19-month high of 2.476% hit Monday and cooled slightly on a report that Germany planned to release some of its oil reserves.
Investors also awaited more details after reports suggested the International Energy Agency (IEA) is to propose the largest release of oil reserves in its history.
Britain and Italy feel the heat
The renewed rise in energy prices also hurt Britain's volatile government bond market, with short-dated yields rising more than 10 basis points.
Natural gas and oil make up a high share of British energy demand at around 35% each, according to the IEA, leaving Britain exposed to price rises.
Britain's government debt is almost 100% of GDP and bond markets remain scarred by the Liz Truss crisis of 2022.
Thinner liquidity – the ability to buy and sell an asset quickly – in the gilt market was exacerbating price moves, said Bryn Jones, head of fixed income at Rathbones.
"It has seemingly got worse since the start of the recent conflict. We had expected a rise in yields, but the moves have been aggressive," he said.
Italy – where government debt is more than 130% of GDP and which has a similar oil and gas mix to Britain – saw its bonds hit harder than most of its eurozone peers.
British and European natural gas prices rose around 6%, ICE and LSEG data showed, and have jumped roughly 50% since the war started.
Italy's two-year bond yield was last up 7 basis points to 2.432%, although it remained off Monday's 14-month high of 2.646%.
U.S. short-dated borrowing costs also climbed, but the moves were less marked than those in Europe, in part reflecting the U.S. position as an oil and gas exporter.
Still, the U.S. economy is not immune to higher energy prices and American rate-cut bets have also been pared back.