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A global bond sell-off deepened on Thursday, sending big nations’ borrowing costs back to their highest levels of the year, as a surge in oil prices above $100 a barrel reignited fears of an inflation shock.
The 10-year German yield climbed 0.03 percentage points to 3.21 per cent, its highest level since 2011. US Treasury yields rose to their highest in 18 months, as the prospect of a lasting increase in oil prices redraws expectations for central bank interest rates.
Escalating strikes between the US and Iran have shredded investors’ hopes that the Strait of Hormuz can be fully reopened to seaborne crude and that the global economy can avoid a prolonged energy crisis. Iran-backed Houthi militants have also this week announced a blockade of Saudi Arabia, sending crude prices to a seven-week high on Thursday.
“Investors just wanted to move on and forget about Hormuz but that always felt like wishful thinking,” said Mike Bell, head of market strategy at RBC BlueBay Asset Management. “Sticking one’s head in the sand isn’t a strategy for dealing with political risk.”
Yields have moved higher as oil prices climbed, with Brent crude rising from just above $70 a barrel in early July to as high as $101 a barrel on Thursday.
The benchmark 10-year Treasury yield, which sets a reference borrowing rate for global debt markets, reached as high as 4.71 per cent, its highest since January 2025, overtaking its previous wartime peak of 4.69 per cent reached in May.
Other global bond yields set multiyear highs this week, with the 10-year French bond yield touching 4 per cent for the first time since 2009. The equivalent yield on gilts climbed 0.07 percentage points on Thursday to 5.10 per cent, still below its May high. Bond yields rise when prices fall.
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While oil prices remain some way short of the $126 a barrel reached in May, investors said the rise in yields showed that the market was bracing for a longer-lasting energy-driven inflation surge, as the prices of diesel, petrol and natural gas jump.
The march higher in borrowing costs during the war, adding to a big jump in recent years as central bank policy has normalised since the Covid-19 pandemic, has piled pressure on indebted governments.
Italy, the UK and Canada are expected to spend about 8 per cent of government revenues this year on debt interest, and the US almost 12 per cent, according to a Fitch Ratings report this week. It warned that the war would “have an adverse impact on [developed markets’] public finances this year through weaker GDP growth, higher interest costs and, in some cases, moderate energy subsidies”.
Investors will be keenly watching a series of central bank meetings for signs of rate-setters’ response to the latest burst higher in energy prices.
Oil inventories that were called upon in the first march higher in oil prices also offer less protection this time, investors worry. The Bank of England warned last month in its yearly financial stability report that in the event of a re-escalation there might be “limited scope for previous partial mitigants”, such as the release of countries’ strategic oil reserves, to put downward pressure on prices.
The European Central Bank, which has already increased rates since the oil-price surge, held rates steady at its meeting on Thursday but warned that uncertainty “remains high and the full inflationary impact of the energy shock has yet to play out”.
Traders are expecting at least two further quarter-point rate increases by next April, according to derivatives markets. The Federal Reserve is expected to deliver two quarter-point rate rises by January.
This represents a big turnaround from the expectations before the Iran conflict, when traders were expecting the Fed and other central banks to cut interest rates.
Bets on higher rates have also been encouraged by stronger US economic data and a hawkish shift at the Fed. New Fed chair Kevin Warsh, at his first policy meeting last month, indicated he was prepared to raise interest rates if necessary and signalled his independence from US President Donald Trump, who has long pressured the central bank to cut interest rates.
Expectations of Fed rate rises — and the move higher in the 10-year Treasury yield — accelerated on Thursday after the US reported the lowest number of weekly jobless claims since 1969. Initial applications for unemployment benefits fell by 22,000 to just 187,000 in the week to July 18.
Analysts said a strong labour market coupled with a hot US economy would allow the Fed to raise interest rates in response to inflation without worrying about a deleterious effect on US consumers.
Short-term inflation expectations have ticked up: the two-year US inflation swap has crept from 2.27 per cent last week to 2.34 per cent.
“Even though interest rate hike expectations are rising, inflation expectations are not dropping,” said Jon Hill, head of US inflation strategy at Barclays. “That suggests this is an inflation problem that the Fed can’t necessarily fix.”
Data visualisation by Ray Douglas
