Government bond markets from Tokyo to New York extended losses on Monday as surging energy prices linked to the prolonged Iran war reignited fears of persistent inflation and forced investors to reassess expectations for global interest rates.
The selloff pushed borrowing costs sharply higher across major economies, with investors increasingly worried that central banks may have to abandon hopes of monetary easing and instead consider further rate hikes to combat inflationary pressures stemming from the energy shock.
The renewed bond rout also cast a shadow over global equity markets that had rallied strongly in recent weeks on enthusiasm surrounding artificial intelligence-related investments.
Oil prices continued have continued to climb after diplomatic efforts to end the Iran conflict appeared to stall, intensifying fears of supply disruptions and broader economic fallout.
Source: Reuters
Japanese bond yields hit multi-decade highs
The global rout was led by Japan whose bond market remained under intense pressure amid mounting concerns over inflation and government borrowing.
The yield on the benchmark 10-year Japanese government bond climbed to as high as 2.800%, marking its highest level since May 1997.
The move came after reports indicated Tokyo was considering a supplementary budget for fiscal 2026 to soften the impact of elevated crude oil prices through subsidies and economic support measures.
Investors fear the additional spending will further worsen Japan’s already strained fiscal position and increase government borrowing requirements.
“Fiscal risks are just beginning,” analysts at Société Générale wrote on Friday, warning that Japanese government bonds, particularly longer-dated maturities, were likely to remain under pressure.
Markets are also increasingly concerned that the Bank of Japan has moved too slowly in tightening monetary policy, allowing inflation to become more entrenched across the economy.
The central bank’s cautious pace of interest-rate increases has weakened the yen significantly in recent months, forcing Japanese authorities to intervene repeatedly in currency markets.
Investors are now betting inflation in Japan could remain elevated for years.
The country’s five-year inflation break-even rate — a key gauge of medium-term inflation expectations — has climbed to 3%, overtaking the equivalent US measure of 2.7%.
Treasury yields surge in the US
The selloff was equally severe in the United States, where Treasury yields rose sharply as markets increasingly priced in the possibility of renewed Federal Reserve tightening.
Benchmark 10-year Treasury yields climbed as much as 3.6 basis points to 4.631% in early Monday trading, the highest level since February 2025.
The yield has surged more than 20 basis points over the past week alone.
The two-year Treasury yield, which is particularly sensitive to monetary policy expectations, touched a 14-month high of 4.105%, while the 30-year Treasury yield rose to 5.159%, its highest level in a year.
The sharp moves followed a series of hotter-than-expected inflation readings in recent weeks, particularly in the United States, which have unsettled investors already concerned about the economic impact of rising oil prices.
Goldman Sachs analysts said US Treasurys had become a less effective hedge against portfolio volatility in recent months.
“Continued uncertainty around the Iran conflict and supply shock remains an impediment to nominal duration’s ability to dampen day-to-day portfolio volatility, which can sustain greater risk premium in the short term,” Goldman analysts wrote.
However, the bank added that Treasurys could regain appeal as a medium-term hedge if inflation risk premiums continue building along the yield curve.
Expectations of a Fed rate hike increase
Markets are now pricing in more than a 50% probability that the Federal Reserve could raise interest rates by December, according to CME FedWatch data.
Before the escalation of the Iran conflict, investors had widely expected rate cuts later this year.
“There has been a dramatic shift in the expectations for US monetary policy as the markets are now pricing in a hike in 2026,” Danske Bank analyst Kristoffer Kjaer Lomholt said in a note.
Ed Yardeni, president of Yardeni Research, said rising global bond yields and persistent inflation pressures were forcing central banks to reconsider their easing bias.
Yardeni said the bond market itself was effectively pushing the Federal Reserve towards a more hawkish stance, with the possibility of a rate hike as early as July if inflation risks continue intensifying.
European, UK bonds affected by inflation and political uncertainty
European government bond markets also weakened further as investors reassessed inflation and fiscal risks across the region.
Germany’s 30-year Bund yield rose by 0.02 percentage points to 3.69%, marking the highest level for long-term German borrowing costs since 2011.
In Britain, the yield on 30-year government bonds eased slightly to 5.808% after touching a 28-year high of 5.85% on Friday amid investor anxiety surrounding domestic political uncertainty and deteriorating fiscal conditions.
Mohit Kumar, economist at Jefferies, said inflation concerns and rising government deficits were increasingly weighing on bond markets globally, with Britain becoming a focal point for investor anxiety.
“Inflation and deficit concerns have been in the background for a while. UK was probably the catalyst for bringing these concerns to the fore,” Kumar said.
He warned that political uncertainty surrounding Prime Minister Keir Starmer had fuelled fears of increased public spending at a time when Britain’s fiscal position was already under pressure.
“A shift to the left would imply a further increase in public spending, even though the government does not have the fiscal room to do so,” Kumar said.
Oil shock revives fears of stagflation
The broader selloff in bonds was driven largely by the relentless rise in energy prices.
Brent crude futures traded near $111 a barrel on Monday after drone strikes triggered a fire at a nuclear power plant in the United Arab Emirates, while efforts to secure a ceasefire between the US and Iran appeared to have stalled.
The continued closure of the Strait of Hormuz — through which a substantial share of global oil exports flows — has heightened fears of supply shortages and prolonged energy disruptions.
More than two months into the conflict, investors are increasingly concerned that elevated energy prices could spill into broader inflation across economies already struggling with high living costs.
Governments worldwide are also facing growing fiscal pressure as they roll out subsidies and relief measures to shield households from rising fuel and electricity costs.
Eric Robertsen, head of global research and chief strategist at Standard Chartered, said investors were becoming increasingly worried about the strain on public finances.
“Fiscal risks are one of the key economic and financial risks for the second half of the year,” Robertsen said.
Nearly 80 countries have introduced emergency measures aimed at protecting consumers and businesses from surging energy prices.
Richard Yetsenga, head of research at ANZ, warned that the combination of rising energy prices, elevated debt burdens and fiscal stimulus posed a particularly difficult challenge for policymakers.
“There’s an uncomfortable confluence of events right now. The fiscal backdrop is the poorest going into any crisis we’ve experienced,” Yetsenga said.
“The energy crisis itself is negative for fiscal because the pressure on governments to subsidise households,” he added.
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