As investors, we are all accustomed to a certain degree of volatility in equity markets during periods of geopolitical uncertainty. From this perspective, what we have observed in recent months is hardly surprising. In fact, one could argue that equities have shown remarkable resilience, despite inflationary pressures that are real, persistent and fully acknowledged by central banks. The reaction of the other major pillar of diversified portfolios has been very different.Fixed income markets, and government bonds in particular, which are often labelled as “safe assets” almost by definition, have failed to play their traditional defensive role.
When, in late February 2026, the United States launched direct military operations against Iran, many investors expected an almost automatic response from bond markets: buying of government securities, falling yields and a return to the classicflight to quality. This pattern has played out repeatedly in past geopolitical crises. This time, however, the script was different.
From the very first days of the conflict, bond markets moved in the opposite direction. Yields on US Treasuries, German Bunds and UK Gilts rose decisively, signalling broad-based selling pressure on government bonds. The implicit message from markets was clear: the conflict was not being treated as a purely geopolitical shock, but as a macroeconomic event with strong inflationary implications.
The main transmission channel was energy. Iran’s direct involvement immediately reignited concerns over global energy supply security, particularly around the Strait of Hormuz, a critical chokepoint for global oil flows. The sharp rise in oil prices pushed inflation expectations higher at a time when inflation had not yet fully normalised in advanced economies. Faced with this backdrop, bond investors began demanding higher yields to compensate for the risk of purchasing power erosion, selling bonds already held in portfolios.
This shift had an immediate impact on monetary policy expectations. Prior to the conflict, a meaningful part of the market was pricing in rate cuts during 2026, especially in the United States. As the military escalation unfolded and the energy shock intensified, those expectations were quickly reassessed. At times, markets even began to price the possibility that central banks might be forced to keep rates unchanged for longer, or potentially adopt a more restrictive stance should inflation reaccelerate.
Fiscal considerations added further pressure. A prolonged conflict implies higher military spending, wider public deficits and, over time, increased government bond issuance. This outlook pushed up the so called term premium, the compensation investors require to hold long dated bonds in an environment of heightened macroeconomic and fiscal uncertainty. Unsurprisingly, longer maturities were hit hardest, with yield curves steepening and long end rates bearing the brunt of the adjustment.
The overall result was an unusually fragile bond market during a period of war. Bonds did not act as portfolio stabilisers; instead, they became a source of volatility themselves. Each escalation headline pushed yields higher, while even tentative signals of de escalation or temporary pauses in military operations triggered only brief and often short lived price rebounds.
In essence, markets are treating the US–Iran conflict as an inflationary shock rather than a systemic crisis. As long as the conflict remains unresolved and energy supply risks remain credible, bonds are likely to stay under pressure. This dynamic resembles past energy crises far more than short, contained military episodes, helping to explain why many investors are approaching government bonds with far greater caution than traditional theory would suggest.
A useful parallel can be drawn with developments observed in 2025 during the escalation of tariffs imposed by the Trump administration. At that time, announcements and subsequent trade tensions with China and Europe generated significant macroeconomic uncertainty. Markets rapidly began pricing an uncomfortable mix of higher inflation and weaker growth, a combination that is historically negative for nominal bonds.
The impact was clearly visible in Europe. Italian government bonds experienced rising yields across the curve. The ten year benchmark, which had previously traded at relatively compressed levels, gradually repriced higher as tariffs were increasingly perceived as persistent rather than negotiable. The dominant driver was not an aggressive widening of sovereign spreads, but a distinctly macro driven move: the belief that a more inflationary and less cooperative global environment would make a rapid easing cycle by the European Central Bank less likely.
A similar, albeit less pronounced, pattern emerged in French government bonds. Prices declined and yields rose, particularly in the medium to long segment of the curve, reflecting an increase in term premium. Investors began demanding greater compensation to hold European sovereign debt amid trade fragmentation, rising production costs and potential pressure on public finances. French bonds remained relatively more defensive than peripheral debt, but they too failed to provide the traditional anchor expected in pure risk off phases.
The parallel with today is striking. In 2025, tariffs acted as an exogenous inflationary shock; today, war plays that role through the energy channel. In both cases, bond markets responded by pushing yields higher and prices lower, not because a recession was seen as imminent, but because inflation was expected to remain more persistent and monetary policy less accommodative. This is precisely the pattern currently observed across Treasuries, Bunds, Italian bonds and French government debt.
Against this backdrop, the performance of corporate credit has been notably different. Credit markets have followed government bonds higher in yield terms, but without showing a more severe deterioration. In several respects, corporate bonds have proven more resilient than sovereign debt.
The most aggressive repricing has occurred in risk free rates, driven by inflation concerns and the reassessment of monetary policy expectations. Corporate bonds have been affected mechanically, as they are priced over government curves, but credit spreads have widened only modestly. After years of extreme compression, investment grade and high yield spreads have moved slightly wider, though so far this appears more like a technical adjustment than a sign of genuine credit stress.
The reason is straightforward: markets are not yet interpreting the current environment as a widespread corporate solvency crisis. Many companies enter this phase with stronger balance sheets than in previous cycles, ample liquidity and well distributed debt maturities. Moreover, in several sectors – including energy, defence, infrastructure and utilities – the geopolitical shock and higher commodity prices have actually improved cash flow visibility, providing a degree of natural inflation hedging.
Another key factor is carry. With government yields rising, the income offered by corporate credit has become more attractive in absolute terms, without a disorderly move in spreads. This has helped sustain demand, particularly for high quality investment grade credit, and prevented a prolonged closure of primary markets.
Caution remains warranted. Should the conflict persist and energy prices remain elevated for an extended period, pressure on margins for energy intensive companies and on consumer demand could emerge with a lag. In that scenario, spreads – especially in lower quality segments – could begin to widen more meaningfully. For now, however, this is not the base case priced by the market.
Taken together, recent developments highlight a fundamental shift in the way war interacts with bond markets. We are not operating in a traditional risk off environment, but in a regime where the cost of capital is being structurally reassessed. In a world of persistent inflation risks, cautious central banks and rising fiscal constraints, the primary risk for bond investors is not credit per se, butuncompensated duration, particularly at the long end of yield curves.
In this context, the most rational response is not to abandon fixed income altogether, but to manage risk selectively. Maintaining exposure to credit allows investors to continue benefiting from attractive income streams and corporate fundamentals that, at least for now, remain broadly stable. At the same time, reducing or neutralising exposure to the most vulnerable segments of the yield curve helps contain volatility and prevents rate movements from rapidly eroding total returns.
The resulting portfolio construction places carry at the centre of the return profile, while actively controlling macro risk. It is neither a passive defensive stance nor a directional bet on rates, but a positioning consistent with a world in which central banks are cautious, inflation is more persistent and geopolitics has become a structural rather than episodic factor.
As long as markets continue to interpret war primarily as an inflationary shock rather than a systemic crisis, this balance appears appropriate. Credit can continue to play a role within portfolios, but only alongside a clear understanding of where risks reside and which components require active management. In an environment where bonds are no longer automatically “safe”, true protection lies not in eliminating risk, but in allocating it correctly.
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