1. War, shock and monetary policy
The current conflict in the Middle East has changed the world economic landscape and, consequently, the bond markets. One the eve of the first US strikes on Tehran, the German 10-year benchmark bond yield was around 2.7%, whilst that of the US government bond with the same maturity stood at 4% per cent. Nearly seven months later, the former stands at around 3.5%, whilst the latter is approaching 5.3%.
The oil shock that followed these initial strikes explains this rise in yields and has led to renewed inflationary pressures. These pressures have fuelled the correction in the bond markets and have also called into question the monetary policy stance adopted in 2024. In February, headline inflation in Europe was below the 2% target, allowing the European Central Bank (ECB) to consider a further cut to its key interest rate. Since then, inflation has risen to around 3.8% and the ECB has raised its deposit rate by 50 basis points to 2.5%.
This is not the first oil shock in history, and past shocks have taught us that it is not only a matter of oil prices or politics; it is also a challenge for governments (which pay the bill), central banks (which may be forced to choose to let prices spiral) and the fixed-income markets. In 1973 (Yom Kippur War) and then in 1979 (Iranian Revolution), central banks had either been too accommodative, deciding to protect growth, or had been slow to act (Volcker, who was chairing the Federal Reserve, did not intervene until well after the sharp rise in inflation). In 2022, facing inflationary pressures driven by both the recovery from the health crisis and the energy shock linked to the war in Ukraine, they had, on the contrary, worked to fight them by raising interest rates drastically, thereby supporting the rebalancing of supply and demand. In 2026, the same central banks are once again being forced to act.
