With markets currently facing a geopolitical shock, courtesy of the United States-Iran war, investors are turning to government bonds for refuge, only to discover that this playbook isn’t delivering as intended.
What’s derailing government bonds from behaving like the reliable, safe-haven assets is inflation concerns, driven by higher oil prices, that are outweighing growth fears and disrupting this traditional risk-off template.
In a typical risk-off environment, investors tend to shift in lockstep from pursuing high returns to prioritising capital preservation due to fear or uncertainty.
However, the March 2026 oil shock, driven by Middle East conflict fears, has severely undermined government bonds.
Yields have spiked as investors dump debt, in anticipation that rampant energy-driven inflation will force central banks to hike interest rates rather than cut them.
This has shattered the "safe haven" status of bonds, triggering a global bond market sell-off.
Duration uncertainty
It remains to be seen whether a sustained rise in oil prices - reinforced by transport disruptions - will meaningfully impact global inflation paths; yet markets aren’t waiting around to find out, they’re already moving.
The duration of this latest Middle East war - set to escalate beyond the four to five weeks predicted U.S. President Donald Trump - remains a crucial piece of the puzzle.
With markets having already moved to scale back rate cut expectations – a repricing that looks increasingly premature - Laura Cooper, global investment strategist at global asset manager Nuveen, is now watching investors seek safety more selectively.
She’s concerned that tighter monetary policy will not only curb demand – rather than offset a supply-side shock – but also risk making existing large-scale economic problems even worse.
Cooper believes the key question for policymakers is whether higher energy costs de-anchor inflation expectations or are ultimately viewed as a temporary supply blip that self corrects.
Have central banks snookered themselves?
What’s adding to an already complex macroeconomic backdrop is the realisation that rates markets have already moved.
As a case in point, pricing for a full Fed cut has shifted toward September from July, Bank of England easing bets have been pared back sharply, and ECB expectations have pivoted from a possible 2026 cut to an extended policy pause.
In Australia, the Reserve Bank of Australia (RBA) shifted from a bias toward easing to a hawkish stance in early 2026, raising the cash rate to 3.85% in February 2026.
The central bank now indicates rates will remain higher for longer, with economists forecasting further hikes in March and May 2026 to combat inflation.
What concerns Cooper is that central banks are entering this [tightening] phase with less policy flexibility, fiscal dominance risks, and greater uncertainty around the growth-inflation trade-off.
“That backdrop argues for a delay in policy moves rather than a structural shift in rate paths,” warns Cooper.
Rethink true portfolio protection
In short, Cooper is concerned that central banks may have overplayed their hand and reminds investors that not even the Fed can ease a supply-side inflation shock caused by an unexpected event that disrupts production.
She cites estimates from the Federal Reserve Bank of Dallas suggesting that even a worst-case closure of the Strait of Hormuz – through which roughly 20% of global oil supply flows – will have only modest, largely transitory effects on core inflation and price expectations.
“Higher energy prices also act as a tax on consumers. With limited buffer for U.S. households already, the drag on real incomes would weigh on growth, and over time, support a more accommodative stance rather than a tightening one,” she notes.
“Importantly, monetary tightening is designed to curb demand, not resolve supply shocks. Central banks can reduce demand, not produce more oil.”
Having concluded that geopolitical shock is inflationary at the margin – while the recent flight to safety in Treasuries already beginning to fade - Cooper is convinced that fiscal dynamics matter now more than incremental monetary policy shifts.
Meanwhile, she expects the forces currently challenging Treasuries’ safe haven status - notably a large fiscal impulse, asymmetric inflation and political pressure on the Fed – to persist.
“While the net effect of the shock remains unclear, the implication is not a rethink of central bank policy paths, but a reassessment of what constitutes true portfolio protection,” she reminds investors.
Copper highlights five takeaways that shape markets
- Policy pauses, not pivots: Markets have moved quickly to pare back rate cut bets, but risks still skew toward cuts coming later in the year from the Fed and BoE rather than a structural shift in policy.
- Long-end yields remain driven by fiscal dynamics: Geopolitical-led rates rallies are likely to fade as fiscal concerns re-emerge – favouring up-in-quality credit and income generating assets over long-end government bonds.
- Dollar strength is tactical, not structural: Haven flow may support the currency near term, but the longer-term trend remains towards gradual diversification.
- Emerging markets face asymmetric risk: Higher energy costs and dollar strength create familiar pressure points, but dispersion is wide, and EM fundamentals remain supported, creating selective opportunities.
- Volatility will reinforce structural dispersion: Selective opportunities continue to emerge – while traditional safe havens face renewed challenge.
