As US-Iran war drags on, bond markets warn of a new inflation wave

Twelve weeks into the US and Israel's war with Iran, the US’s 30-year treasury yields closed at 5.18 per cent on May 18, the highest level since July 2007. The UK and Japan’s long bonds set fresh records last week. India followed. China was the lone holdout. The G7 average 10-year sovereign yield is approaching four per cent, up from 3.2 per cent before the war began in late February, Reuters reported. Read Full Story On Monday, the US 30-year treasury briefly touched 5.197 per cent before closing at 5.18 per cent. The all-time peak of 5.36 per cent from June 12, 2007, still stands, but only 17 basis points away. The 10-year Treasury yield is at 4.6 per cent, the highest in more than a year. In London, the 30-year gilt yield climbed to 5.85 per cent on May 15, a fresh high in the 2005-onwards series, before pulling back to 5.72 per cent on Tuesday. UK long bonds have been the most stressed in the G7 since last autumn's statement, as the gilt market continues to digest the Liz Truss-era pricing wobble. Tokyo set its own record. Japan's 30-year yield closed at 4.15 per cent on Monday, up 29 basis points over the past five trading days, the biggest move in the si country panel we track. For most of the past two decades, the long JGB traded between one and two per cent. Germany's 30-year Bund closed at 3.68 per cent on Tuesday, the highest reading since 2011. India's 30-year G-Sec, structurally the highest yield in the panel at 7.69 per cent, is up only seven basis points over the week; domestic factors, not Tehran, still drive the long end of the rupee curve. The picture is not uniform. China's 30-year yield slipped to 2.24 per cent, the only major sovereign curve moving the opposite way. Domestic deflation, not the Iran headlines, drives the long end of the Chinese bond market. Yields are down more than 200 basis points from their December 2013 peak of 5.2 per cent, even as every other long-end yield on the panel has risen. The signal from bond markets worldwide is unmistakable: the cost-of-living crisis, worsened by the Middle East conflict, is here to stay for some time. According to a May 15 Reuters report, bond markets are “bracing for interest-rate pain in a way they have not in decades, as investors assess the economic costs of the war with Iran and how the global economy will bear those burdens”. Treasury yields represent the interest governments pay to borrow money. Higher yields mean borrowing costs for governments around the world are set to rise sharply. They also signal higher interest rates for other borrowers, as many lending rates are benchmarked against treasury yields. Yields typically spike when investors expect inflation to rise. Other contributing factors include weak economic growth and elevated levels of government borrowing. What it means for us Rising yields signal a prolonged high-interest-rate environment. This increases borrowing costs for governments, corporations, and consumers alike. Higher borrowing costs, in turn, can lead to reduced consumer spending, slower corporate investment, and tighter government expenditure. Such an environment typically results in slower economic growth and weaker job creation. It is no surprise, then, that stock markets across the world are sliding, taking cues from the turmoil in bond markets. The government of India is set to borrow nearly Rs 17 lakh crore this fiscal year, while state governments are expected to borrow an additional Rs 12–13 lakh crore. With such a large borrowing programme, even a small increase in interest rates can significantly raise interest payment outflows — an added strain that governments can ill afford at a time when the provision of sops has become the new normal. With growth expectations moderating amid a rising interest rate environment, the rupee continues to slide. The Indian currency touched yet another record low on Tuesday, falling nearly six per cent since the Iran war began. The war has sent ripples across energy markets, with the strategic Strait of Hormuz, a key lifeline for global energy trade, effectively shut for around 80 days. As a result, oil and gas prices have surged to multi-year highs and continue to climb. For consumers, a higher interest rate regime means paying more on home and car loans, alongside an inflation spiral that will place additional pressure on household finances at a time when jobs are hard to come by, salary growth is modest, and elevated energy costs are likely to persist. And the slide in the rupee poses its own set of challenges. Ends