Investors sold U.S., European and U.K. government bonds Tuesday on fears that rising oil prices due to the Middle East conflict would spill over into inflation, potentially delaying or preventing further interest-rate cuts.
The scope of the Middle East crisis has been expanding since the first attacks by the U.S. and Israel on Iran on Saturday, with airstrikes and drones targeting military air bases and airports across the region leading to civilian casualties and material damage.
“The parallel rise in oil and natural-gas prices amid tensions around the Strait of Hormuz further intensifies inflation concerns,” said Terence Hove, financial markets strategist consultant at Exness. “Higher energy costs risk slowing the pace of disinflation, keeping core measures elevated and anchoring yields higher.”
The 10-year U.S. Treasury yield last traded 4 basis points higher at 4.093% while short-dated Treasury yields rose by even more, according to Tradeweb.
German and U.K. yields reached two-and-a-half-week highs. The 10-year German Bund yield climbed 7 basis points to 2.785% and the 10-year U.K. gilt yield jumped 13 basis points to 4.498% ahead of the U.K. government’s spring budget statement.
The price of a barrel of Brent crude rose 5% to $81.62. The dollar continued to strengthen against major currencies, with the DXY dollar index hitting a six-week high of 99.126.
U.S. President Trump on Monday said that the U.S. military operation, named Operation Epic Fury, could last four to five weeks or “far longer.”
Investors centered their focus on the longer-term inflationary impact of higher energy prices rather than on the safe-haven nature of bonds.
“The price action at the start of this week once more underscores that Bunds and U.S. Treasurys no longer function as safe havens,” Christoph Rieger, head of rates and credit research at Commerzbank, said in a note.
“We would expect [U.S. Treasurys] to rally and yields to fall, but that is the opposite of what we saw on the first trading day after the air strikes,” BNY’s John Velis said.
Eurozone inflation expectations for year-end have increased to 2%, up from 1.85% on Friday, Commerzbank’s Rieger said.
“As a result, European Central Bank rate expectations have also shifted up, with the market abandoning hopes of a rate cut this year,” he said.
In the U.S., money markets continue to price in a next rate cut by the Federal Reserve for September, but with a lower probability, according to LSEG data. Similarly, markets currently price in about 55 basis points of rate cuts through June 2027, compared with around 68 basis points before the strikes on Iran.
In the U.K., investors have slashed expectations for a rate cut from the Bank of England in March. Money markets now price in only around a 30% probability of a rate cut this month, down from 83% priced in last week, LSEG data show.
Write to Emese Bartha at emese.bartha@wsj.com