Global markets have been in turmoil since the first US and Israeli attacks on Iran at the end of February. This is because soaring oil prices are putting pressure on stock prices, and even so-called safe assets are being dragged into volatility. Government bonds, which are often used to hedge portfolios against riskier assets such as stocks, are no exception. Bond yields and prices move in opposite directions. Developed country government bonds are typically seen as stable investments that can hedge stock market volatility in portfolios, so yields typically fall as investors seek safety and stock prices plummet. But in the initial aftermath of the U.S. and Israeli attack on Iran, sovereign debt joined the decline in stock markets around the world, causing bond yields to spike. Bonds in developed countries have largely followed the decline in stocks since the start of the war. Yields have experienced wild swings, deviating from the behavior typically seen for “safe” assets during stock market downturns. By last Friday, trading in developed market bonds had calmed down after another volatile week. Oil prices fell slightly on Friday but still rose as President Donald Trump said the US had “unlimited ammunition and plenty of time” to continue the war and US Defense Secretary Pete Hegseth dismissed concerns about closing the Strait of Hormuz. Global stock markets were mixed, with European and US stock markets moving much more subdued than in recent trading. Oil prices rose again on Monday morning as the Trump administration stepped up pressure on allies to help protect the Strait of Hormuz and investors reacted to the threats facing export facilities in the Middle East. International benchmark Brent crude oil futures (for May delivery) rose 3% to $106.18 per barrel, while US West Texas Intermediate (for April delivery) rose 2% to $100.66. Gilts (British government bonds) 5-year and 10-year bond yields fell by 2 basis points to 4.8% and 4.3%, respectively. Luke Hickmore, director of fixed income investments at Aberdeen Investments, said in a note on Thursday that government bonds have “defied their safe-haven status” since the dispute began. This is due to the sharp rise in oil prices, which directly affect transportation costs, heating costs, and the prices of moving goods in the economy, he said. “As oil prices soar, so does the risk of inflation. Even if headline inflation has been easing to date, rising energy costs will put a lower bound on how much and how quickly inflation can fall,” he added. “Bond investors are very concerned about that. Bonds provide fixed income. If inflation is higher than expected, those payments lose purchasing power,” said Luke Hickmore, director of fixed income investments at Aberdeen Investments. Investors are looking for higher returns to compensate for the potential loss in purchasing power, which is why yields are rising significantly and bond prices are falling as stocks are falling, said Luke Hickmore, director of fixed income investments at Aberdeen Investments. “In the past, investors would rush into government bonds and geopolitical shocks would often drive down yields. This time is different.” “The shock is being driven by energy prices and inflation, not by a collapse in demand. Bonds are not a haven when inflation is an issue.” Wayne Nutland, investment manager at Shackleton Advisors, said that while a variety of factors affect returns, bond and stock returns tend to be negatively correlated during periods of negative growth shocks – when economic growth is less than expected, bond prices rise and stock valuations often fall. “The lack of credit risk in government bonds, along with their ability to provide positive returns during economic downturns, is why bonds are often referred to as a ‘safe haven’ asset,” he told CNBC in an email. But he noted that bond and stock returns often move in tandem when rising inflation is the driver of market returns. “Rising inflation concerns push up bond yields (leading to lower bond prices) and also negatively impact stock returns through lower valuations and concerns about lower earnings,” Natland said. “There’s little mystery about what’s going on in the markets right now. A spike in oil prices following military action in the Middle East has raised inflation expectations, increasing the positive correlation between bond and stock returns.” “Hope is not a strategy,” Toni Meadows, head of investment at BRI Wealth Management, told CNBC that the pattern seen in the bond market reflects the fact that “inflation concerns are outweighing growth concerns for now.” “Stock prices have also rebounded, which speaks to the fear,” Meadows said. “Uncertainty does not necessarily drive investors into government bonds.” He said monetary policy measures could increase demand for safe assets, including bonds, if economic growth is squeezed by war or high energy prices, but noted that this trajectory is not guaranteed. “In this case, a cessation of hostilities would lead to a rate cut, but given the risk premium in oil prices, prolonged inflation could dampen rate cuts,” Meadows said. “Fear of inflation may therefore deter purchases of safe-haven assets across the curve.” Lauren Hyslop, a fund manager at Mattioli Woods, cautioned against making premature speculations about how the conflict might play out. He noted that yields plunged earlier this week when oil prices fell after President Trump suggested the war could soon end. “Traders have rushed for a swift policy change from the central bank,” he said, noting that the bond market was “effectively betting on a clean and contained war” in response to President Trump’s words. “The problem is that all of these assumptions are still highly controversial,” she says. “Oil prices are rising, the duration of the war is unknown, and inflation risks are not gone, only temporarily ignored. As the old adage goes, hope is not strategy.” — CNBC’s Bryn Bache contributed to this article.
