Global debt markets swing between war risks and peace prospects

The Iran war rattled global bond markets throughout May, sending government borrowing costs sharply higher before signs of progress in peace negotiations and weaker economic data helped reverse some of the moves.

The sharp swings highlighted investor concerns about inflation, central bank policy, and rising public debt levels.

While a lasting end to the conflict could provide immediate relief to bond markets and reduce government borrowing costs, investors remain wary about longer-term economic risks.

Treasury market hit by inflation fears

The US Treasury market experienced significant volatility during the month.

The yield on the 30-year US Treasury rose to around 5.2% on May 20, reaching its highest level since 2007 as the Iran conflict intensified pressure on global debt markets.

The sell-off was driven by concerns that peace talks between the United States and Iran were stalling.

Those concerns pushed oil prices above $110 per barrel and added to worries about inflation.

Strong US inflation data also contributed to the rise in yields.

The surge was not limited to the United States.

Government bond yields in Britain and Japan climbed to multi-decade highs during May.

Some Japanese yields reached record levels, while Germany's 10-year bond yield touched its highest level since 2011.

Economic slowdown supports bond recovery

Bond markets later recovered as oil prices declined and diplomatic developments suggested progress in negotiations between Washington and Tehran.

At the same time, weaker economic data, particularly from Europe, reduced expectations that central banks would need to aggressively raise interest rates.

Data released last week showed euro zone economic activity contracted at its fastest pace in two-and-a-half years during May as higher energy costs weighed on the region.

US diverges from Europe

Despite the broader recovery in bond markets, the United States remained a relative underperformer during May.

US 10-year Treasury yields increased by 6 basis points between April 30 and May 29.

In contrast, German 10-year yields fell by 6 basis points over the same period.

While economic weakness in Europe reduced expectations for further rate increases, the US economy remained resilient.

Continued strength was supported by an artificial intelligence spending boom.

As a result, traders eliminated expectations for Federal Reserve rate cuts this year.

At one point, markets briefly priced in a full 25-basis-point rate increase by December.

Data released on Thursday showed the Fed's preferred inflation measure rose 3.8% year-on-year in April, marking its fastest pace in three years.

The yield spread between US and German 10-year government bonds widened to 1.51 percentage points, its highest level since mid-2025.

UK gilts face another turbulent month

The UK gilt market also experienced sharp volatility during May.

Thirty-year gilt yields climbed to 5.87% in mid-May, their highest level since 1998.

The rise reflected both the global bond sell-off and concerns that a successor to embattled Prime Minister Keir Starmer could pursue higher government spending.

However, UK bonds later rallied as hopes for peace increased, domestic economic data weakened, and leading contender Andy Burnham pledged to maintain the government's fiscal rules.

Between April 30 and May 29, 10-year gilt yields fell by roughly 21 basis points, outperforming both US Treasuries and German bonds.

Even so, yields remained substantially higher than before the conflict began.

Fiscal concerns add to market pressure

Longer-dated government bonds suffered the most during the mid-May sell-off, reflecting concerns beyond inflation alone.

Inflation-adjusted real yields also rose in both the United States and Europe, indicating growing investor concerns about economic and fiscal conditions.

Bank of America analysts said they believed a major factor behind the Treasury market sell-off was ever-worsening fiscal dynamics.

Some investors also expressed concerns about the independence of new Federal Reserve Chair Kevin Warsh, who was appointed by US President Donald Trump.

The combination of inflation risks, fiscal concerns, and uncertainty surrounding central bank policy ensured that bond markets remained highly sensitive to developments throughout May.