Despite a recent ceasefire between the U.S. and Iran, which led to a rally in stocks and bonds and Brent crude futures falling below $100 per barrel, bond strategists warn that yields are unlikely to return to pre-war levels. The FTSE World Government Bond Index slid more than 3% in March, marking its sharpest monthly drop in 1 1/2 years. While the ceasefire reduced immediate inflation panic by allowing the reopening of the Strait of Hormuz, other factors continue to exert upward pressure on borrowing costs.
Key drivers keeping yields high include the ongoing struggle of major economies to bring inflation back to target, increased public debt burdens, and the significant capital demand from the AI investment boom as tech companies acquire semiconductors and build data centers. Additionally, central banks like the Federal Reserve are showing a reluctance to cut interest rates, with some even seeing a possibility of rate hikes if inflation persists. Fed funds futures, which at the start of the year priced in at least two rate cuts, now imply barely a 50% chance of a single cut.
In the U.S., rising real yields, which strip out inflation, have been the primary contributor to higher overall yields. Factors like President Donald Trump's tax cut push and trade war further exacerbate the debt burden, increasing the need for Treasury sales. For Japan and Germany, rising breakeven rates, reflecting inflation expectations, have been the main cause of the increase in 10-year yields since the war began. Canada's 10-year bond yield, for example, was down about 5 basis points to 3.44% post-ceasefire, but this remains well above pre-war levels.
Analysts from ING, Goldman Sachs, and Barclays anticipate that even if oil prices retreat, long-term yields will remain elevated due to these underlying pressures. Prashant Newnaha, senior rates strategist at TD Securities, emphasized that central banks will be vigilant to prevent the energy supply shock from fueling higher inflation expectations. Policymakers are largely adopting a wait-and-see approach, rather than cutting rates, as the ceasefire reduces the risk of a global recession.
