U.S. Treasury "fear index" soars to nine-month high; Federal Reserve rate cut expectations "fade"

The ongoing escalation of the Iran conflict has kept oil prices elevated, fueling inflation expectations. The volatility index for U.S. Treasuries has suddenly surged to a nine-month high, and market bets on Fed rate cuts in 2026 have nearly disappeared.

According to Bloomberg on Friday, the ICE BofA MOVE Index, which measures bond market volatility—and is referred to as the "fear index" of the bond market—has risen to its highest level since June last year.

Rising oil prices erode the real returns on Treasuries, diminishing their safe-haven appeal. The 30-year U.S. Treasury yield has climbed to a one-month high, while the two-year yield has reached its peak since August last year.

Meanwhile, Trump has once again publicly called on Fed Chair Jerome Powell to cut interest rates, further intensifying uncertainty about monetary policy prospects. The one-year U.S. inflation swap rate is nearing 3%, indicating that investors expect inflationary pressures to remain strong. Almost all gains in the Bloomberg U.S. Treasury Aggregate Return Index since the beginning of this year have now been wiped out.

Conflict impacts inflation expectations, bond market "fear" spreads

In the two weeks since the Iran conflict erupted, government bond prices in major markets across the globe—from the U.S. to Japan and Australia—have generally declined. The upward movement in U.S. Treasury yields has set the tone for global bond markets, with investors betting that central banks might have to hike rates earlier to counter inflation.

Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said: "As bond investors, we have to start thinking about things from a stagflation perspective, and stagflation has always brought huge uncertainty. Therefore, I need to be compensated for volatility."

Both Trump and Iran have taken tough stances, making the duration of the conflict hard to predict. This uncertainty is a core driving force behind current bond market volatility. Vishwanath Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist, said in an interview: "Faced with such broad uncertainty, I believe volatility will remain elevated for quite a long time."

Stagflation risks emerge, rate cut expectations repriced

As the conflict continues, concerns about stagflation in the market are intensifying. BlackRock Investment Institute has already listed stagflation shock as a major risk scenario, while Loomis, Sayles & Co. warns the conflict may threaten the U.S. fiscal deficit, further depressing bond performance and potentially driving the MOVE index even higher.

Bloomberg strategist Alyce Andres pointed out: "If the situation continues to deteriorate, inflation concerns will further strengthen expectations that the Fed will keep high interest rates for a longer time."

Marcella Chow, Global Market Strategist at J.P. Morgan Asset Management, also stated: "Any ongoing geopolitical tensions, and limited visibility about the outlook, could bring additional pressure to the U.S. fiscal position, thereby triggering further market concerns."

As inflation expectations heat up and geopolitical risks stack up, traders have sharply reduced bets on Fed rate cuts in 2026. The one-year inflation swap rate close to 3% shows that market expectations for future price pressures have risen significantly.

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