Markets react to potential inflation
Since the US/Israel strike on Iran, we first saw yields moving lower, but they have risen again as the oil and gas infrastructure is increasingly attacked. If this continues, the war is further escalating, and higher oil and gas prices could become an issue for future (higher) inflation.
In such a scenario, central banks may become more hawkish in their rhetoric, as they signal hiking interest rates to counter inflation risks. This would be felt more in Europe than the US, as Europe is more energy dependent. Government bonds have not engaged in a classic flight to quality, as inflation could move up the term-premia at the long end of the yield curve.
The current outright yield level looks to be enough, for now, to keep government bonds in their trading ranges, which has been set since the summer of 2025. Corporate credit risk spreads have also moved up slightly, but this is a relatively muted move, as you would have expected more widening and better all-in yield levels.
Looking at a broader range of financial instruments, it looks that market participants still believe that the current tense situation in the Middle East could be resolved within a short timeframe of 8 to 10 weeks. The market can position for that. But now, with further escalation and attacks on the energy infrastructure, it could mean that going back to “normal” by repairing and restarting oil and energy production, could take more time. Oil price movements are highly correlated with the different asset classes. With this in mind, we continue to favour high-quality corporate bonds and the shorter end of the curve, due to an expected hawkish stance by central banks. It is too early to buy long duration and to pick up lower credit quality bonds, such as high yield, although opportunities could occur in the coming weeks.