Inflation concerns: Are rates markets at a turning point?

Key takeaways on a poten­tial tur­ning point in rates mar­kets: 

1. Rising energy prices due to the Iran conflict are fuelling concerns about a more restrictive monetary policy.
2. This development comes at an inopportune time for highly indebted countries like the United States.
3. In this scenario, we see opportunities in short-term US bonds and European government bonds, among others.

How quickly times change. Just a few weeks ago, the market largely anticipated that major central banks would either ease their key interest rates or at least keep them steady. The U.S. Federal Reserve (Fed) had already cut rates three times in 2025, and investors were pricing in further rate cuts for 2026. Meanwhile, the U.S. inflation rate seemed to be gradually approaching the 2% target. Similar trends were observed with the European Central Bank (ECB) and the Bank of England.

But then, on 28 February, the Iran conflict erupted, turning the global bond landscape upside down almost overnight.

Turning point in bond markets: Rising energy prices ignite inflation concerns

Since then, the sharp rise in energy prices triggered by the Middle East conflict has reignited inflation fears and fundamentally altered market expectations. Hopes for rate cuts have given way to concerns that central banks may be forced to adopt more restrictive monetary policies to curb inflation driven by soaring energy prices. Investors’ reactions have been clear: the bond market has experienced what is known as a bear flattening. This means that yields have risen across all maturities, especially at the short end of the yield curve.

British government bonds – Gilts – have been hit hardest by this development. But refinancing costs have also risen significantly in the U.S. and the Eurozone. For the United States, this development comes at a particularly inopportune time. On 17 March 2026, the country’s gross national debt surpassed USD 39 trillion for the first time. Rising interest rates put pressure on an already strained fiscal situation, as a growing share of the budget must be allocated to debt servicing. This has reignited debates about the status of U.S. government bonds, or “Treasuries,” as a safe haven.

Taking a nuanced view of U.S. debt

In our view, the current situation requires a nuanced perspective. While the high level of U.S. debt is a structural issue, it should not be overemphasised in a cyclical context. For the short-term interest rate decisions of the Federal Open Market Committee (FOMC), it plays a minor role. Structurally, however, higher risk premiums for U.S. bonds may become necessary, which could primarily affect the long end of the yield curve in the long term.

Unlike the ECB, which must focus strictly on combating inflation, the Fed operates under a dual mandate: it must also consider the labour market. While there are initial signs of a cooling labour market, it remains resilient overall. This gives the Fed more flexibility in shaping its monetary policy. The ECB, on the other hand, is compelled by its mandate to respond more mechanically as a hawk, raising interest rates.

Market participants’ expectations for the monetary policies of major central banks by the end of 2026 (interest rate steps in %)

Turning points compared: How rates markets in 2026 differ from 2022

The current situation is markedly different from the conditions in 2022 during the COVID-19 crisis. Supply chains are more resilient today, and central banks are starting from an already restrictive interest rate environment. While significant rate hikes were needed in 2022 to achieve a neutral monetary policy, we are already in a slightly restrictive environment in 2026. Financial conditions also appear significantly tighter than they were back then.
The current pricing of rate hikes suggests to us that the market may have reached a new equilibrium – a view supported by stable long-term inflation risk premiums, despite the recent surge in energy prices.

Where caution is needed in rates markets – and where opportunities lie

How can investors respond to such an environment? In our view, short-term USD bonds still offer attractive investment opportunities. Treasuries remain among the most liquid assets in the bond universe – and this liquidity can be highly valuable, especially in a volatile environment. It allows investors to act quickly when opportunities arise. Additionally, we find the current interest rate levels – particularly at the short end of the curve – to be attractive. We see potential to benefit from the increased current yields.

European bonds are also likely to reach their yield peaks. This is despite the fact that the ECB will likely maintain a cautious stance for longer due to the delayed impact of the energy crisis on inflation figures. We see some renewed value in peripheral bonds but recommend staying close to the benchmark duration in EUR. Additionally, we have built smaller positions in CHF and CAD, which represent lower-beta options. In Europe, however, we are gradually reducing positions in inflation-linked bonds, or linkers, while continuing to increase longer-dated linkers in the U.S.

Should the Fed shift its focus more towards the labour market in this environment, long-term inflation expectations in the U.S. could also rise. It is important to note that linkers trade on inflation expectations rather than current inflation – an aspect that makes the Fed appear less restrictive than the ECB.

Emerging markets worth considering

For more risk-tolerant investors, adding emerging market debt (EMD) to their portfolios could also be worthwhile. These bonds typically offer higher real yields and stable currencies, which could outperform developed markets. For instance, we had already added Hungarian and Mexican bonds to our portfolios before the outbreak of the conflict.

However, some caution is warranted: our strategy assumes that commodity markets will stabilise in the coming weeks and reach a “new normal.” If the conflict escalates further and commodity prices trigger second-round effects, we will reassess the situation promptly.