Author: Fiona Craig

A de-escalation in tensions between the United States and Iran could lead to lower Treasury yields, but Wolfe Research believes rates are unlikely to fall back to the levels seen before the conflict erupted.

In a note released this week, Wolfe Research analyst Stephanie Roth estimated that around half of the nearly 40-basis-point increase in 10-year Treasury yields since the start of the war was driven by the Iran-related shock. The rest of the move, she said, stemmed from stronger economic growth data and the unwinding of a February rally tied to AI-related concerns.

“If/when there is an agreement with Iran, we would not expect yields to return to pre-war levels,” Roth wrote.

According to Wolfe Research, only part of the conflict-related rise in yields is likely to reverse. The firm estimates that “roughly 10–15bp of the war-related move would reverse, with the balance remaining due to firmer growth and a residual risk premium.”

That outlook would keep 10-year Treasury yields trading above pre-conflict levels, in an estimated range of 4.15% to 4.40%.

To assess the increase in yields, Wolfe Research used a sign-restriction model based on daily rate movements. The analysis attributed approximately 19 basis points of the rise to the Iran shock, about 15 basis points to growth repricing, and the remainder to an “other” category.

Roth added that energy prices are expected to remain elevated even if a diplomatic agreement is reached, while lingering geopolitical uncertainty could preserve part of the market’s risk premium. Those conditions, she noted, may prevent a complete reversal in war-related yield gains.

Regarding Federal Reserve expectations, Wolfe Research said the market-implied probability of a rate hike has climbed to roughly 44%. The firm believes that level appears somewhat high relative to its base-case scenario, suggesting there may be room for those expectations to ease, especially if a peace agreement is reached.

Global stock markets climbed to new highs this week after reports of a possible peace agreement between the United States and Iran helped break what Barclays described as “market paralysis.”

However, the bank warned that broader equity gains remain vulnerable while the Strait of Hormuz remains closed.

Semiconductor stocks continue to dominate market gains

According to Barclays, semiconductor shares have significantly outperformed the broader market since January, rallying strongly against the MSCI World Index while the benchmark excluding semiconductor stocks has shown little overall progress.

The brokerage warned that the semiconductor rally is “starting to look extended,” although it added that the move remains “backed by strong earnings,” following first-quarter results that comfortably exceeded expectations, largely driven by artificial intelligence and technology companies.

“Wider market breadth and a continued melt-up in equities are contingent on tangible progress regarding the reopening of the Strait of Hormuz,” Barclays said.

Barclays warns energy buffers are shrinking

Barclays said the impact of the energy shock has so far been managed through the use of existing inventories, but cautioned that “these buffers are eroding fast, with the risk of demand destruction rising incrementally.”

The bank noted that European markets have been among the hardest hit by the current environment.

Since the conflict began, consumer-facing and interest-rate-sensitive sectors within the MSCI Europe Index have posted the steepest declines, while only the Technology and Energy sectors have generated positive returns, according to Barclays Research.

The brokerage also cited EPFR data showing that Europe ex-UK equity funds have experienced outflows in seven of the last eight weeks.

U.S., Japan and emerging markets remain preferred regions

Barclays said it continues to favour U.S., Japanese and emerging market equities over European stocks.

The bank said it prefers sectors connected to long-term investment and technology trends, as well as banking stocks, over consumer-focused sectors.

If the Strait of Hormuz reopens, Barclays believes European equities could outperform on a relative basis because of their “sharp underperformance since the war started.”

The bank added that consumer and rate-sensitive sectors would likely benefit the most from any resulting short-covering rally.

Equity inflows remain subdued

EPFR data referenced by Barclays showed that weekly equity inflows totalled $2.6 billion, well below the year-to-date weekly average of roughly $20 billion.

U.S. equity funds attracted $9.3 billion during the week, while emerging market funds recorded $11.6 billion in outflows, marking a fourth consecutive week of withdrawals.

Money market funds posted their second weekly inflow above $100 billion this year following three weeks of substantial outflows.

So far this year, equity funds have attracted $338.2 billion, compared with $272.7 billion for fixed income and $238.8 billion for money market funds.

UK markets pressured by higher gilt yields

In the United Kingdom, Barclays noted that 30-year gilt yields climbed earlier this week to their highest level since 1998 before partially easing.

The bank added that homebuilder shares have fallen more than 20% since the conflict began as tighter financial conditions weighed on the sector.

Barclays also noted expectations that Labour could lose a substantial number of local election seats.

However, the bank’s economists said any change in party leadership would likely not result in major policy changes before autumn, with potential alternatives expected to remain “sensitive to market concerns around maintaining the fiscal rules.”

Markets await key economic data and U.S.-China summit

Looking ahead, investors are preparing for several major economic releases next week.

The U.S. consumer price index report for April is due on May 12, with Bloomberg consensus forecasts pointing to monthly inflation of 0.7% compared with 0.9% previously.

U.S. retail sales figures are scheduled for May 14 and are expected to show growth of 0.4%, down from the prior reading of 1.7%.

The United Kingdom will also release first-quarter GDP figures on May 14.

Meanwhile, a summit between the United States and China is scheduled to take place in Beijing on May 14.

Inflation-linked bonds, often promoted as protection against rising prices, have struggled alongside the broader bond market as the war involving Iran fuels inflationary pressures across the global economy. At the same time, surging equity markets have continued to attract investor attention.

Since the conflict erupted at the end of February, BlackRock’s London-listed global inflation-linked government bond ETF has declined by roughly 2%, according to LSEG data. That performance closely matches losses seen in the asset manager’s global government bond ETF, while the S&P 500 has climbed 7% and reached record highs this week.

Rising Rates Undermine Traditional Inflation Protection

“TIPS (U.S. inflation-protected bonds) and linkers generally provide relative inflation protection versus nominal bonds,” said Jonathan Hill, head of U.S. inflation strategy at Barclays. “If you think that it’s a pure inflation hedge, then you’re going to be disappointed.”

Inflation-linked bonds are designed to preserve investors’ purchasing power over the long term because their payments are tied to inflation indices. However, in shorter timeframes, they remain vulnerable when markets expect central banks to raise interest rates or delay previously anticipated rate cuts.

As yields rise, the fixed income generated by existing bonds becomes less attractive compared with newly issued debt carrying higher returns. Inflation-linked securities are therefore not immune to broad bond market selloffs.

Large institutional investors such as pension funds that hold these securities until maturity can still benefit from their inflation-adjusted payouts. Yet in the near term, prices can weaken when real yields — interest rates adjusted for expected inflation — increase.

“If inflation goes up, but real yields go up as well, then the duration side of the bond sells off the same as all bonds,” said Hill. Duration refers to a bond’s sensitivity to changes in interest rates, with longer-dated securities typically more exposed.

Investors Shift Toward Equities and Commodities

“Generally fixed income is unattractive,” said Dorian Carrell, head of multi-asset income at Schroders. “You’re better off looking for inflation-adjusted revenue streams, probably on the equity side” — with materials, energy and utilities presenting opportunities.

Investors have increasingly gravitated toward sectors expected to benefit from inflation and commodity price strength, while global stock markets continue to rally strongly.

Shorter-Dated Linkers Attract Interest

Despite the recent weakness, some investors remain interested in inflation-linked bonds. BlackRock data showed that $2.6 billion flowed into inflation-linked ETFs during March, marking the largest monthly inflow since Russia invaded Ukraine in 2022. Another $2.2 billion was added in April.

Part of the appeal comes from stronger long-term performance relative to conventional government bonds. Barclays’ Hill noted that shorter-dated U.S. inflation-linked securities have delivered significantly better returns than the wider Treasury market over the last five years because they are less exposed to sharp moves in yields that can outweigh inflation adjustments.

He added that persistent price pressures tied to factors such as U.S. tax cuts and heavy investment in artificial intelligence could continue to support these securities. Inflation-linked bonds also tend to outperform regular bonds when inflation rises unexpectedly.

“As we’ve seen in the past, short-dated linkers may well work, but long-dated linkers can carry too much duration in an inflation-induced bond market sell-off,” said Lloyd Harris, head of fixed income at Premier Miton Investors.

Portfolio Managers Seek Alternative Inflation Hedges

Many inflation-linked bonds have relatively long maturities. In Britain, for example, the average maturity of index-linked gilts reached 18 years in 2024, compared with 13 years for conventional government bonds.

Marion Le Morhedec, global fixed income CIO at Fidelity International, said her team has instead been using inflation swaps and breakeven trades to express views on future inflation trends more directly.

“The question is really how long this inflation uncertainty will remain,” she said. “Definitely what we are doing in our portfolios is really to keep those short-dated inflation protections.”

Inflation has accelerated in several major economies following the spike in energy prices linked to the Iran conflict. U.S. inflation rose to 3.3% in March from 2.4% in February, while UK inflation also climbed to 3.3% in March. Inflation in the euro zone increased to 3% in April.

Market Momentum Continues to Favor Risk Assets

As inflation concerns intensify, investors have also looked toward assets benefiting directly from higher commodity prices. Bond giant PIMCO noted last week that commodities had “behaved largely as theory would suggest,” posting strong gains during the recent turmoil.

Meanwhile, BlackRock’s Investment Institute said it remains “neutral” on inflation-linked bonds while maintaining an “overweight” position in U.S. equities.

The firm summarized current investor sentiment by saying: “Contained damage to global growth from the Mideast conflict and strong earnings expectations — particularly in tech — keep us risk-on.”

Oil prices advanced on Friday after fresh hostilities between the United States and Iran reignited concerns over the durability of the fragile ceasefire and clouded prospects for reopening the Strait of Hormuz, a vital corridor for global crude oil and liquefied natural gas shipments.

Brent crude futures rose 67 cents, or 0.67%, to $100.73 per barrel by 0650 GMT, while U.S. West Texas Intermediate (WTI) crude futures gained 45 cents, or 0.47%, to $95.26 per barrel. Earlier in the session, both benchmarks had surged more than 3% as traders reacted to the latest escalation.

The rebound followed three consecutive sessions of losses driven by optimism earlier this week that Washington and Tehran were nearing a peace agreement capable of halting the conflict, even though broader disputes over Iran’s nuclear ambitions remained unresolved.

Despite Friday’s recovery, both oil benchmarks are still on track for weekly declines of around 6%.

Market volatility intensifies amid geopolitical uncertainty

“The market is on the cusp of a complete breakdown,” said Vandana Hari, founder of oil market analysis provider Vanda Insights.

“Price formation is no longer anchored in a pragmatic reading of the war’s trajectory or the physical realities in the Strait of Hormuz.”

Crude prices accelerated higher after Iran accused the United States of breaching the ceasefire that had been in place for the past month. U.S. officials responded by saying recent military strikes were retaliation for Iranian attacks on U.S. Navy vessels moving through the Strait of Hormuz on Thursday.

Iranian military officials stated that American forces struck both an Iranian oil tanker and another vessel, as well as civilian locations in the Strait and on Iranian soil.

Even with the renewed military activity, U.S. President Donald Trump later told reporters on Thursday that the ceasefire remained operational.

“The U.S. administration continues to oversell the prospects of a thaw, and an optimism-biased market buys into it,” Vanda Insights’ Hari said.

“Curiously, each time, the rebound is gradual and incomplete, making the head fakes at least somewhat effective.”

Supply concerns remain elevated as negotiations continue

The latest confrontation unfolded while Washington awaited Tehran’s response to a revised peace proposal. Reports indicated that the proposal avoided several contentious subjects, including U.S. demands to reopen the Strait of Hormuz, which before the conflict began on February 28 handled roughly 20% of global oil and LNG trade.

“On the supply front, the picture remains tight,” IG analyst Tony Sycamore said in a note.

Separately, Reuters reported on Thursday that the U.S. Commodity Futures Trading Commission has launched an investigation into approximately $7 billion worth of oil trades executed ahead of major Trump announcements related to the Iran conflict.

According to the report, most of the transactions involved bearish positions placed on the Intercontinental Exchange (ICE) and Chicago Mercantile Exchange (CME). The trades reportedly anticipated falling oil prices before Trump announced delays to military action, ceasefire agreements or other Iran-related policy decisions that later pushed crude markets lower.

Gold prices traded slightly higher on Friday and remained on course for a weekly advance as investors balanced optimism surrounding a potential U.S.-Iran peace agreement with ongoing concerns over the stability of the current ceasefire. Market participants also stayed on the sidelines ahead of key U.S. employment figures due later in the session.

Spot gold rose 0.8% to $4,723.52 per ounce by 01:35 ET (05:35 GMT), while U.S. Gold Futures added 0.5% to reach $4,731.96.

Bullion has climbed nearly 2% over the week after recovering from one-month lows touched earlier in May.

Strait of Hormuz tensions keep markets on edge

Investors continued to follow developments in the Middle East after U.S. and Iranian forces exchanged fire on Thursday near the Strait of Hormuz, marking the most serious breach so far of the ceasefire established one month ago.

Iran later stated that conditions in the affected coastal regions had normalized, while U.S. President Donald Trump told ABC News that the ceasefire remained in place.

Although gold is commonly viewed as a safe-haven investment, prices also benefited from easing inflation concerns after hopes for a broader diplomatic agreement contributed to a pullback in oil prices from recent highs.

Reduced inflationary pressure could support gold demand by lowering expectations that interest rates will stay elevated for an extended period.

A softer U.S. dollar earlier in the week also helped support bullion prices.

The U.S. Dollar Index was down 0.1% during Asian trading hours after ending the previous volatile session largely unchanged.

Markets await U.S. labor report for interest rate signals

Traders remained cautious ahead of the upcoming U.S. nonfarm payrolls report, which may provide additional guidance regarding the Federal Reserve’s future monetary policy path.

Economists expect payroll growth of approximately 65,000 jobs, while the unemployment rate is projected to remain unchanged at 4.3%. A weaker labor report could increase expectations for future Fed interest rate cuts and offer further support to non-yielding assets such as gold.

Gold prices have fallen more than 10% since tensions involving Iran escalated in late February, as surging oil prices fueled inflation fears and strengthened expectations for higher interest rates.

Silver, platinum and copper also move higher

Among other precious metals, spot silver gained 1.9% to $79.95 per ounce, while platinum advanced 1.7% to $2,060.30 per ounce.

Benchmark Copper Futures on the London Metal Exchange rose 0.4% to $13,396.33 per ton, while U.S. Copper Futures climbed 1.4% to $6.21 per pound.