Global markets have entered a new and turbulent chapter since the outbreak of war between the United States and Iran on the last day of February. The war has sent shockwaves through energy markets, rattled equity investors, and derailed what was supposed to be a straightforward year for fixed income.

Usually, when geopolitical conflict erupts, the expected response is a flight to safety: investors pile into government bonds, prices rise, and yields fall. However, that wasn’t the case this time. In the days following the onset of hostilities, bond yields moved sharply higher across the curve, which is a sign that markets are far more focused on the inflation threat posed by rising energy prices than on any perceived safety premium in sovereign debt. The US 10-year Treasury yield finished at 4.28% on Friday, up from below 4% just days before the conflict began, more than 30 basis points move in under two weeks. The 2-year Treasury note (part of the curve most sensitive to Fed’s policy expectations) closed at 3.73%, reflecting a decisive repricing of the rate cut trajectory. In Europe, the story is similar – Bund yield has climbed to 2.96% as of March 13 (its highest level since October 2023) and is closing in on the 3.00% threshold. The repricing is global in nature, and the implications for ECB policy are considerable: money markets have swung from pricing in rate cuts before year-end to pricing in two rate hikes by December. ECB rhetoric has turned decisively hawkish, with officials signalling they will not allow a repeat of the inflation shock that followed Russia’s invasion of Ukraine. However, ECB’s hike still appears highly unlikely, despite the rhetoric.  In US, an already difficult to read inflation picture, has grown more complex. Coming into 2026, price pressures had been on a slow but recognisable downward path. The February CPI print came in at 2.4% YoY but released against the backdrop of a severe energy shock which limits the relevance of the print going forward, so the real inflationary impact is still working its way through the pipeline.

At the heart of the disruption is oil and Iran’s effective closure of the Strait of Hormuz which has triggered what the IEA is calling the largest supply disruption in the history of the oil market. Iraq, Kuwait and UAE have reduced oil production by a combined 10 million barrel per day as tanker traffic remains near zero. The IEA’s record 400-million-barrel reserve release has done little to calm markets (at current rates of supply loss, it would be absorbed in under 30 days) and Iran’s stance for now is to keep the Strait closed indefinitely. With 10yr inflation break evens moving higher to around 2.3%, the bond market is already pricing in a meaningful inflation uptick.

From the Fed’s perspective, the US-Iran conflict could create a policy dilemma if the conflict persists. The US labour market had already started to soften before hostilities began; February’s jobs report showed net job losses, and the unemployment rate edged up to 4.4%. But with energy-driven inflation re-accelerating, rate cut doesn’t seem appropriate in the near term, as it could lead into a deteriorating growth and prolonged inflation. Futures markets took notice and already repriced the rate outlook and expected cuts in 2026 have been scaled back.

The bond market is now caught in a tug-of-war between near-term inflation fears and the longer-term risk of an economic slowdown. Should oil prices remain elevated, the stagflation scenario becomes increasingly plausible and neither equities nor bonds offer easy shelter in that environment. The key variable to watch remains the pace of diplomatic resolution of the conflict.