Soaring oil prices reignite inflation threat as global bond markets face a new wave of sharp sell-offs

According to Zhitong Finance APP, as escalating tensions in the Middle East push international oil prices above the $100 mark, inflation concerns have reemerged, leading to a new wave of intense sell-offs in the global bond market. Investors who previously bet on a bottom in the bond market correction have once again suffered losses, and major central banks worldwide now face a critical test of their credibility.

Multiple Factors Trigger Current Global Bond Market Adjustment

This week, UK benchmark government bond yields closed above 5% for several consecutive days, marking the longest streak in nearly 20 years; German 10-year government bond yields reached their highest level since 2011; and Japanese 10-year government bond yields approached highs not seen since the 1990s. The US market is similarly under pressure, with the 30-year US Treasury yield nearing its highest level since 2007, and short-term Treasury yields hitting new highs not seen in more than a year.

This round of global bond market sell-offs is unprecedented in scale, with the Bloomberg Global Government Bond Index—which tracks the performance of investment-grade sovereign bonds—now seeing its average yield soar to 3.68%, breaking through the high from three years ago and reaching its highest level since the 2008 global financial crisis. This benchmark index is currently facing its largest monthly decline since March.

Global Bond Yields Surge

Yields at both the long and short ends of the curve are rising in tandem, putting significant pressure on the bond market as a whole. Coupled with the possibility of more geopolitical news emerging this weekend and major interest rate decisions from the US Federal Reserve, Bank of Japan, and Bank of England next week, the uncertainty in global bond markets continues to escalate.

If the sell-off in bond markets continues to intensify, it could trigger a series of chain reactions: global debt sustainability concerns would become more prominent, corporate financing costs would climb further, and capital may begin rotating from equities to other asset classes, fueling cross-asset volatility.

"A variety of factors are working together," said Torsten Slok, Chief Economist at Apollo Global Management, referring to the rise in global sovereign bond yields. "Persistently rising oil prices are creating policy challenges for key central banks such as the Federal Reserve, the European Central Bank, and the Bank of England."

Since the beginning of this year, global bond markets have suffered significant setbacks due to soaring energy prices triggered by Middle East conflicts. In June, hopes for a US-Iran ceasefire led to a brief pullback in oil prices, but with the recent escalation in the Middle East, oil prices rebounded, and on Thursday the price of Brent crude successfully broke through the $100 per barrel mark, reigniting inflation risks.

The Fed Turns Hawkish, Washington's Reform Amplifies Market Volatility

In addition to the risk of energy-driven inflation, the resilience of the US economy is also pressuring the bond market. Robust performance in the US labor market and economic growth have shifted market expectations for Federal Reserve policy from rate cuts to rate hikes this year.

Meanwhile, the new communication strategy implemented by incoming Fed Chair Kevin Walsh has further amplified market volatility. The new framework substantially reduces the central bank's forward guidance, meaning that policy adjustments may occur sooner than the market previously expected, significantly increasing uncertainty. Current market pricing shows the probability of a rate hike at the Fed's July 28-29 policy meeting has risen to one-third.

"We understand that Walsh doesn't want to provide forward guidance to the market, and that's fine," said Mark Cabana, Head of US Rates Strategy at Bank of America. "But as a result, the market is more able to price what it thinks the Fed should do—or what actions might force the Fed to consider a hike."

The Fed providing less forward guidance could mean that whatever its next decision is, it may catch the market off guard.

Since the Fed's June Meeting, Traders Have Raised Expectations for Rate Hikes

The core focus in markets right now is whether the Fed can effectively signal to the market that inflation is under control. Surging post-pandemic inflation caught central banks off guard, and the bond market has yet to fully recover from the resulting shock. The Bloomberg Global Aggregate Bond Index remains about 20% below its all-time high set in early 2021.

A research report released Thursday by Barclays analyst Anshul Pradhan's team stated: "Rate hikes will prompt the market to reassess the terminal rate, which will flatten the yield curve. If rates remain unchanged with no clear or reasonable policy explanation, it is likely to result in higher long-term yields."

Global Central Banks in a Policy Dilemma, New Macro Landscape Reshapes Asset Pricing

This wave of bond market sell-offs has spread globally, and the Asian market has not been spared. Concerns that the Bank of Japan's pace of monetary tightening is insufficient to curb yen depreciation and inflation pressure have pushed Japan’s 10-year government bond yields higher. Although Bank of Japan officials have signaled an accelerated pace of rate hikes ahead of next week’s policy meeting, concerns in the bond market have not abated.

UK traders will be closely watching the Bank of England’s latest economic forecasts and comments from Governor Bailey, as the market overwhelmingly expects two more rate hikes from the BoE this year. The Bank of England currently faces a policy dilemma: Rising energy prices are fueling inflation risks, but a weak domestic labor market and sluggish economic growth make it difficult to strike a balance between stimulating the economy and curbing price increases.

Australia’s bond market is also under significant pressure. Australia’s benchmark yield currently leads all developed economies, and faces ongoing upside risk. Next week’s inflation data and remarks from Reserve Bank of Australia Governor Bullock may reinforce expectations that the RBA will hike policy rates for the fourth time this year.

Puja Kumra, Strategist at TD Securities London, pointed out the common global central bank predicament: All currently available economic data are lagging indicators that do not accurately reflect the true trend of the economy and inflation, leaving major central banks worldwide confronted with difficult policy choices simultaneously.

The bond market correction has resulted in heavy investor losses. BlackRock’s iShares 20+ Year Treasury Bond ETF, a mainstream long-duration bond investment tool, has seen its net asset value drop by nearly 5% in the past month, and is down more than 50% since 2020.

"We believe we have entered a new macroeconomic environment," said Atsi Seth, Chief Credit Officer at Moody’s Ratings in New York. This means "structurally higher inflation, higher interest rates, growing fiscal deficits, and global uncertainties increasingly shifting from the societal level to the government level—eventually being reflected on the balance sheets of governments around the world."