Global government bond markets are heading toward their steepest monthly decline in years as investors reassess the economic fallout from the war involving Iran, the United States, and Israel. The conflict, now entering its second month, has triggered a sharp rise in oil and gas prices, forcing markets to confront the prospect of renewed inflation at a time when global growth is already under pressure. That combination has driven yields higher across major fixed income markets as investors sell bonds and retreat from earlier expectations of monetary easing.
The shift is significant because government bonds sit at the center of how markets price inflation, recession risk, and central bank policy. For much of this year, investors had been leaning toward the view that slowing economies would eventually allow rate cuts in several major markets. The war has disrupted that logic. Surging energy prices have introduced a new inflation shock, leaving central banks in a far more difficult position and sending bond yields higher in the United States, Europe, Japan, and Australia.
At the same time, Monday brought a partial rebound in some sovereign debt markets, suggesting that investors are beginning to weigh a second possibility: that the hit to growth may eventually become more important than the inflation shock itself. That tension between inflation and stagnation is now defining the bond market narrative.
U.S. Treasuries reflect a sharp policy reset
The U.S. Treasury market has been one of the clearest expressions of that repricing. The two year Treasury yield, which is especially sensitive to Federal Reserve expectations, was on track for a monthly increase of 45 basis points, its largest rise since October 2024. Although it fell 8.6 basis points on Monday to 3.83%, the broader monthly move shows how quickly investors have abandoned the idea of near term rate cuts.
That shift has been particularly striking in interest rate futures. Markets no longer expect the Federal Reserve to lower rates this year and have instead started to price in the possibility of a small increase in the benchmark federal funds rate. The benchmark 10 year Treasury yield has climbed nearly 40 basis points over the month to around 4.39%, reinforcing how deeply the inflation shock has altered the outlook for monetary policy.
Still, Monday’s rebound in Treasuries hinted at a more complex debate. Some investors now appear to believe that if the war drags on, the damage to economic activity may eventually restrain how far central banks can tighten. That would leave the Fed trapped between inflation running around 3% and growth that may be weakening under the strain of higher energy prices.
Europe sees even bigger bond market swings
Moves in Europe have been even more dramatic, with investors rapidly revising their assumptions for both the European Central Bank and the Bank of England. Markets are now pricing in two or three rate hikes from both institutions this year. In Britain’s case, that represents an especially sharp turn, as investors had previously expected two rate cuts before the war upended the inflation outlook.
British government bonds have borne the brunt of that adjustment. The U.K. two year yield has jumped 98 basis points this month, its biggest rise since the turmoil of 2022 during Liz Truss’ short premiership. The 10 year yield has risen 70 basis points. Germany has also seen a major selloff, with its two year yield up 61 basis points on the month and its 10 year yield rising nearly 40 basis points, after reaching a 15 year high of 3.13% last week.
Italy, viewed by many investors as especially vulnerable to an energy shock, has seen similarly sharp moves. Its two year yield has risen 85 basis points this month, while the 10 year is up 78 basis points. Those moves reflect how exposed parts of Europe remain to imported energy costs and how quickly stagflation fears can reshape sovereign debt pricing across the region.
Asia shows a split between pressure and resilience
In the Asia Pacific region, the picture is more mixed. Japanese bond yields have risen strongly, with the 10 year yield on track for its sharpest monthly advance since December and shorter dated yields touching levels not seen in roughly three decades. Australia has also seen a notable jump, with the three year government bond yield up about 50 basis points this month, the biggest rise in 17 months, even though it eased somewhat on Monday.
These moves reflect the same global concern that central banks may have limited room to support growth if the war keeps commodity prices elevated. As in Europe and the United States, higher energy costs are feeding into inflation expectations and creating pressure on yields across the curve.
China has stood apart from that trend. Chinese government bonds have held up relatively well, with the two year yield falling more than 11 basis points and heading for its largest monthly decline since December 2024. Investors appear to be betting that China is better insulated from the oil shock thanks to large crude stockpiles, strong positioning in green energy, and weaker domestic inflation pressures than many Western economies are facing.
Stagflation risks now dominate the outlook
The most important theme running through all of these bond market moves is the return of stagflation risk. Oil prices remain firmly above $100 a barrel and are set to record their biggest percentage gain for March since at least 1988. That kind of energy shock tends to feed directly into transport, manufacturing, and consumer prices while also draining demand and business confidence.
For central banks, that creates a policy dilemma with no easy answer. Raise rates too aggressively and the slowdown could worsen. Hold back and inflation expectations may become harder to control. That is why bond markets have become so volatile. Investors are no longer pricing a simple path toward easier policy. They are trying to judge which side of the equation will dominate first: the inflationary impact of the war, or the economic damage it leaves behind.
Monday’s mild rebound in some bond markets suggests the growth argument is beginning to gain more attention, but it has not replaced inflation as the main driver. For now, sovereign debt markets remain caught between two threats that rarely arrive with this intensity at the same time. Until the war’s economic endgame becomes clearer, that tension is likely to keep yields elevated and volatility high across the world’s most important bond markets.
