Middle East Tensions Cast a Long Shadow on US Treasury Market

The recent escalation of hostilities between Israel and Iran is poised to exert a prolonged influence on the US Treasury market, echoing patterns observed in previous flare-ups. This renewed geopolitical uncertainty, particularly impacting energy prices, adds another layer of complexity for investors already grappling with persistent inflation concerns and a burgeoning US national debt.

The financial world held its breath as benchmark US Treasury yields climbed by nine basis points following Friday's direct confrontation between Israel and Iran. This immediate reaction, fueled by a surge in oil prices and subsequent inflation worries, isn't an isolated incident. History offers a stark reminder: similar episodes, such as Iran's direct strikes in April 2024 and an earlier surge in tensions last October, consistently led to rapid and sustained increases in Treasury yields, often holding firm for a month or more.

"The market is undeniably volatile right now," observes Carlos Casanova, Senior Asia Economist at Union Bancaire Privee in Hong Kong. "Investors are instinctively gravitating towards traditional safe-haven assets, which in turn is pushing crude prices higher. This dynamic is almost certainly going to translate into an uptick in 10-year US yields."

These geopolitical tremors arrive at an already precarious time for Treasury investors. The ongoing specter of worsening inflation, exacerbated by factors like President Donald Trump's trade policies and growing concerns over the US's spiraling national debt, has already created a challenging landscape. Now, with the Middle East situation directly influencing global energy markets, traders are demanding a higher premium for the perceived risk of lending to governments, a demand that is likely to further propel yields upward.

Across the board, US yields have seen increases, though shorter-term bonds have experienced relatively smaller gains. This differential has led to a steepening of the yield curve, with two-year US yields rising eight basis points since Thursday's close.

"The pressures to steepen the Treasury curve could very well continue," cautions Wei Liang Chang, a Singapore-based Macro Strategist at DBS Group Holdings Ltd. He adds, "Investors might also be factoring in the potential for increased military expenditure over the long term, a direct consequence of a more unpredictable geopolitical environment. Moreover, the risk of inflation becoming entrenched, especially if oil prices remain elevated, is a significant concern."

In essence, the latest chapter in the Israel-Iran conflict serves as a potent reminder of how interconnected global events truly are. For the US Treasury market, this isn't just a fleeting blip; it's a deep-seated ripple that could reshape investment strategies for the foreseeable future.