Inflation concerns overshadow safe-haven buying, and the rare conflict between Iran and the U.S. has dealt a heavy blow to the U.S. bond market!

Cailian Press, March 3 (Editor: Xiaoxiang) In the $30 trillion U.S. Treasury market, inflation has once again become investors’ primary concern. The market widely worries that a prolonged conflict in the Middle East could keep oil prices at elevated levels for an extended period.

In recent weeks, “safe-haven buying” has been the dominant force in the U.S. debt market. Driven by a sharp stock market decline and escalating tensions between the U.S. and Iran, investors sought refuge, leading to the strongest monthly performance for U.S. Treasuries in a year in February.

However, with the outbreak of Middle East hostilities over the weekend causing oil prices to surge, this safe-haven trading abruptly halted on Monday…

As rising oil prices reignite inflation fears, investors have begun to decisively sell bonds. Major global asset managers like BlackRock and PIMCO have previously warned that inflation is highly “sticky,” and current developments confirm this view.

This shift has caused a complete reversal in market sentiment toward U.S. Treasuries. Data shows that the yields on 2-year U.S. Treasuries rose by 10.23 basis points to 3.475% on Monday, while 10-year yields also increased by nearly 10 basis points to 4.036%. Meanwhile, traders have lowered expectations for the Fed’s rate cuts this year.

According to industry statistics, Monday saw the largest single-day increase in the 10-year Treasury yield since at least June last year.

Jan Nevruzi, a strategist at TD Securities, said: “The risk-reward profile for safe-haven buying in fixed income assets has now diminished. From a retrospective perspective, the rate markets may have already priced in a cooling of geopolitical tensions, but they did not fully anticipate an escalation of the situation.”

The Fed May Keep Rates Higher for Longer

Currently, traders are preparing for the Federal Reserve to maintain higher interest rates for an extended period. The futures market has pushed back the expected timing of the next rate cut to September, with only two 25-basis-point cuts expected this year, and a third cut possibly not until 2027.

JPMorgan Chase CEO Jamie Dimon stated in an interview on Monday, “The risk of inflation being higher than expected does exist, and if it materializes, it’s like a ‘skunk at the party.’ Hopefully, that won’t actually happen.”

Additionally, war costs are becoming an external factor that cannot be ignored—they could lead to further expansion of the U.S. budget deficit and force the U.S. Treasury to issue more debt. President Trump has said that U.S. military action against Iran could last 4 to 5 weeks, and has claimed that preparations are underway for a “much longer” operation. Iran has also launched attacks across the region in retaliation.

Subadra Rajappa, head of U.S. rates strategy at Société Générale, said: “The core focus now is high oil prices and their transmission effects on overall inflation. Whether this situation persists depends on how long the U.S.-Iran conflict continues.”

As U.S. bond sell-offs intensify, a report shows that manufacturing activity in the U.S. expanded in February, with input costs surging. With the Strait of Hormuz effectively closed, energy costs have risen, causing European government bonds to decline in tandem, and inflation expectations in the market to spike sharply.

Oil Prices Will Significantly Impact Bond Yields

A report from Deutsche Bank last week pointed out that, compared to geopolitical shocks themselves, the rise in oil prices has a more “pronounced” effect on yields. The bank analyzed major geopolitical events over the past decades (such as Iraq’s invasion of Kuwait in 1990, 9/11, and the Russia-Ukraine conflict) and reached this conclusion.

Fidelity International fund manager Mike Riddell has now increased profit-taking positions on long-term U.S. Treasuries, as long-dated bonds are more sensitive to fiscal risks.

He explained, “Government subsidies for energy and food prices have become a trend. If the Middle East crisis persists, this trend will intensify, making long-term sovereign bond yields extremely vulnerable at current levels.”

Of course, some industry insiders believe the safe-haven attributes of U.S. Treasuries will eventually reassert themselves. Before the U.S.-Iran conflict erupted, Treasuries experienced a strong rally in February, driven by concerns over losses in the private credit sector and disruptions from AI in the stock market. This rally temporarily pushed the 10-year yield below 4% for the first time since November last year.

George Catrambone, head of fixed income at DWS Americas, said, “In the absence of unexpected events, the market focus should return to the data itself. I believe issues related to private markets and some tech investments and valuations are still unresolved.”

John Taylor, head of European fixed income at AllianceBernstein, also said that the safe-haven appeal of U.S. Treasuries might return: “If the conflict and high oil prices last too long, concerns about negative economic consequences (such as recession) will grow, which could ultimately push U.S. Treasury yields lower.”