Bond market crashes! Renewed Iran conflict sparks inflation panic, global bond index posts biggest drop since last May

The flames of war in the Middle East have reignited, and the traditional safe-haven logic of the government bond market is collapsing. Inflation concerns are once again dominating the global fixed income market, as government bonds are widely sold off from Sydney to Tokyo.

US, Japanese, Australian, New Zealand, South Korean, and Indonesian government bonds all posted losses this week. Bloomberg’s global bond index fell 0.8% on Monday, marking the largest single-day drop since May last year. On Monday, the US 10-year Treasury yield surged by 10 basis points; on Tuesday, the Australian 10-year government bond yield jumped up to 12 basis points to 4.75%; the Japanese 10-year government bond yield rose 6 basis points.

According to CCTV News, on Monday, March 2 local time, Trump stated that the "big wave" against Iran had not yet begun, that actions against Iran could last four or five weeks, and preparations had been made for a duration far beyond this. The US Secretary of Defense said ground troops had not yet been deployed within Iran's borders, and all potential actions remain possible.

Former CEO of Pacific Investment Management Company Mohamed El-Erian warned that amid rising geopolitical risks, a new wave of "stagflation" is sweeping the global economy, and its ultimate impact will depend on the duration and scope of the conflict. Several market participants cautioned that this situation could drive global bond markets into sustained sell-offs.

Energy Shock Drives Yields Higher, Loose Policy Expectations Repriced

This round of bond market sell-off has overturned conventional market logic. Under normal circumstances, geopolitical crises tend to drive capital flow into government bonds and other safe-haven assets, pushing yields lower. But expectations of rising energy prices due to the Iran conflict are breaking this traditional pattern.

Macquarie Bank strategist Gareth Berry pointed out:

Contrary to popular belief, energy supply risks triggered by a Middle Eastern outbreak typically drive global bond yields higher, rather than lower. At this moment, expectations for monetary easing have already been priced in, and these expectations now suddenly look hard to realize – the effect is particularly conspicuous.

Bloomberg market strategist Mark Cranfield also said:

Overnight signals from the US Treasury market are negative, and it will be an even worse day for Asia-Pacific fixed income markets. Furthermore, if the Japanese 10-year government bond auction results are weak, it could spark a broader bond sell-off.

For investors, uncertainty about the length and scope of the conflict has pushed inflation concerns back to center stage, steadily eroding the safe-haven allure of sovereign bonds during times of geopolitical tension.

Geopolitics Returns to the Macro Stage: A Structural Shift May Be Underway

The main source of inflation threat is rising oil and gas prices - about one-fifth of global seaborne oil supply normally passes through the Strait of Hormuz, which is now nearly at a standstill. Moreover, higher airfares, increased transportation costs, and broader supply chain risks, if the conflict continues, will add layers of inflationary pressure.

Bloomberg Economics researchers Ziad Daoud and Dina Esfandiary pointed out that if oil prices stay high, major oil-importing countries such as Europe and India will be significantly impacted, while exporting countries like Russia, Canada, and Norway will benefit. For the US, consumers will feel pressured by rising fuel costs, but thanks to shale oil making the US an oil exporter, the overall economy would be less affected.

Many market participants believe that this conflict may mark the start of a deeper structural shift, rather than merely a short-term risk event.

Monica Defend, head of Amundi Investment Institute under Allianz Group, wrote in a report:

The Iran crisis reinforces the structural shift we have long emphasized: geopolitics is once again becoming a cyclical macro driver. Energy volatility, inflation uncertainty, and regional divergence are again defining characteristics for markets.

Mohamed El-Erian also pointed out that the US government bond market has clearly chosen to prioritize inflation concerns, and the ultimate impact of the conflict will be determined by its duration and scope. Whether the bond market can stabilize largely remains an unknown that depends on developments in the battleground.

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