Mideast War Ignites Inflation, Central Banks Eye Hikes

Bonds, which had seen a strong start to the year, are losing their haven appeal as traders anticipate prolonged Middle East instability will drive up oil prices and supercharge inflation. This shift is forcing central banks to reassess monetary policy, with previous expectations for easing now appearing less likely.

European Central Bank Chief Economist Philip Lane warned of a "substantial spike" in inflation and output drop, leading traders to price in a near 50% chance of an ECB hike this year, a stark reversal from earlier cut expectations. Similarly, Australia's central bank chief, Michele Bullock, indicated a potential rate increase this month, causing Australian yields to jump 14 basis points.

US 10-year yields also rose, contributing to a 0.8% slide in a Bloomberg global bond gauge. Experts like Mohamed El-Erian note a "stagflationary wind," while Amundi's Monica Defend highlights geopolitics as a returning macro driver.

China remains an outlier, with its bond market stable due to central bank liquidity and easing expectations. The duration and spread of the conflict, particularly its impact on energy prices, remain critical variables for investors.