Even if the US and Iran reach a ceasefire, Wall Street still expects "high interest rates to persist."

The US-Iran conflict has driven up oil prices and intensified inflation concerns, but the real logic of the bond market is much more complex than the narrative of war. Wall Street strategists warn that even if the Strait of Hormuz reopens and the inflationary pressures brought by war fade, long-term interest rates will still find it hard to drop significantly—because the structural forces driving yields higher have long existed independently of geopolitical conflicts.

On May 25, Bloomberg reported that strategists from Wall Street investment banks such as ING, Goldman Sachs, and Barclays believe that the recent surge in US long-term yields is mainly driven by the "real yield" after removing inflation factors, rather than the market pricing in war-induced inflation. This means that even if oil prices drop, Treasury yields may remain "stuck" at high levels, continuing to exert pressure on the government and real economy.

According to a Wallstreetcn article, US officials said Sunday that both sides were close to reaching an agreement to reopen the Strait, but Trump stated he would not sign the agreement "rashly." As a result, oil prices dropped sharply in early Asian trading on Monday, US Treasury futures rose slightly, driving Treasury yields down somewhat, and the US 10-year Treasury yield approached 4.70% last week. Yet, several strategists clearly pointed out that the market's repricing of interest rates reflects structural issues that cannot be reversed by a single diplomatic statement.

Real Yields are Center Stage, Inflation Not the Main Cause

According to Bloomberg's analysis, in the US, the rise in real yields explains most of the overall yield increase, with inflation expectations contributing relatively little.

Jonathan Hill, Head of US Inflation Strategy at Barclays, remarked that attributing the recent global duration selloff to inflation worries is inconsistent with actual market pricing. He said, "Rising debt levels, a potentially higher neutral rate, and the impact of artificial intelligence might be the true drivers behind the rise in real rates."

Data also supports this judgment. Hill pointed out that even during the war, the US 10-year breakeven inflation rate remains about 50 basis points lower than during the Fed's aggressive rate hike period in the first half of 2022; the 5-year 5-year forward breakeven rate, which measures medium-term inflation expectations, is around 2.2%, basically unchanged from last December.

ING’s Head of Americas Research, Padhraic Garvey, was even more direct: he believes the entirety of the recent rise in the US 10-year yield above 4.5% comes from the increase in real yields. He stated,

"Even if the Strait reopens, it will only suppress inflation expectations, but real yields may still stay at high levels. In that case, Treasury yields will not drop as much as many expect."

Fiscal Deficit and Debt Pressure Form a Long-Term Anchor

Apart from real yields, worsening fiscal conditions in the US are another key driving factor.

The tax cut plan promoted by Trump will further expand the already massive debt scale, leading to greater demand for Treasury issuance; meanwhile, ongoing trade wars are disrupting supply chains and adding to economic uncertainty.

Phillip Lee, Head of Real Funding Rate Sales at Goldman Sachs, said that persistent fiscal deficits, more Treasury supply, and worries about debt sustainability increasingly explain why investors demand higher compensation for holding long-term bonds. "I think rates will keep rising."

JPMorgan CEO Jamie Dimon also warned last week that US interest rates could climb much higher due to worries over government borrowing and debt demands.

Bank of America economists Claudio Irigoyen and Antonio Gabriel monitor the shape of the yield curve to judge market drivers. They pointed out that in an environment where the Fed may raise rates and fiscal deficits expand further due to rising debt interest payments, long-end rates will become a lot more sensitive to movement in short-end rates.

AI Boom Puts Short-Term Pressure on Rates

Additionally, the wave of AI investment has been factored into the analytical framework, becoming a new variable driving rates higher.

Bond traders worry that AI’s short-term impact is to exacerbate inflation—as tech companies consume vast amounts of semiconductor resources, build large-scale data centers, and issue considerable debt in the market. Although AI may suppress inflation in the long term by boosting productivity, this effect will take time to materialize.

Moreover, economic growth expectations driven by AI may also incline investors to hold stocks, thus requiring bonds to offer higher yields to compensate for opportunity costs.

Jonathan Hill said the neutral rate may have already shifted higher, meaning that a 5% yield on 10-year US Treasuries is no longer a "bargain." Mark Malek, Chief Investment Officer at Muriel Siebert & Co., wrote in a client report:

"The bond market is not reacting to just one news headline—it’s repricing based on a structural issue that cannot be solved with a press release or diplomatic pause."

In other major markets, the logic driving yields higher differs.

Bloomberg data shows that in Japan and Germany, since the outbreak of war, the rise in 10-year yields has been mainly driven by the increase in breakeven inflation rates, with inflation factors holding much more weight than in the US.

In Japan, inflationary pressure had been building up even before the war, and the Bank of Japan’s reluctance to raise interest rates has forced investors to demand greater compensation for inflation risk.

In the UK, Prime Minister Keir Starmer faces increasingly severe challenges to his administration. The market worries this could lead to further expansion of fiscal policy and more gilt issuance—only four years removed from the extreme turmoil triggered during former Prime Minister Liz Truss’s term.

John Sidawi, Senior Portfolio Manager at Federated Hermes, stated,

"You want to make long-term thematic judgments on UK gilts, but rising political uncertainty almost forces you to trade tactically. Compared to other developed markets, UK gilts will always embed a certain risk premium."

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