Market commentary bonds: War in Iran: Oil price, inflation and economic shock
At the start of the year, the conflict in the Middle East had a noticeable impact on the capital markets. Rising energy prices, shifting interest rate expectations and higher credit risks are the result. Dr Harald Henke, Principal Investment Strategist Fixed Income, analyses what the market reactions reveal about inflation, the economy and current market positioning.
Dr. Harald Henke
Principal Investment Strategist Fixed Income
Key takeaways
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Inflationary pressure remains high: The rise in oil prices appears persistent and is coinciding with a weaker economy.
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Interest rate markets signal a slowdown: The flattening of the yield curves points to rising growth risks.
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Risk premiums are rising in a differentiated manner: Spreads are widening, particularly in Europe, and sectoral differences are increasing.
The global economy was hit by another shock in early 2026 as the conflict between Israel, the US and Iran escalated, including attacks on key energy infrastructure. The closure of the Strait of Hormuz and rising transport risks have severely disrupted energy flows, materially increasing the risk of broader damage across the region’s energy system.
Rather than making a forecast about the further course of the conflict and its impact on the global economy and financial markets, we wish to analyse market movements to date and draw conclusions regarding the state of the market.
Interest rates: Which effect dominates – inflation or interest rates?
Interest rates in the US and Germany initially rose significantly across all maturities. Figure 1 shows the trend in ten-year interest rates.
Figure 1: Ten-year interest rates
Over the first month, the rise amounted to 30–35 basis points, pointing to a revaluation of real interest rates in the market. Interestingly, following an initial parallel shift, the yield curve flattened significantly in the course of March, as shown in Figure 2:
Figure 2: Steepness of yield curves in the first quarter
Whilst the yield curve shifted largely in parallel during the first few days of the conflict, after a few weeks the market came to the conclusion that the economic shock was greater than initially assumed. Consequently, yield curves on both sides of the Atlantic flattened.
For further discussion and empirical evidence, we recommend our article “Oil price shocks, demand for safe-haven assets and US interest rate dynamics”.
Market interest rate expectations
In the meantime, the market has repriced central banks’ interest rate policies and has priced in three further rate hikes for Germany, as well as two rate cuts and one rate hike for the US, as can be seen from the implied interest rate expectations derived from money market futures.
Figure 3: Implied interest rate expectations from money market futures
Panel A: Germany
Panel B: US
As can be seen from the figures, three rate hikes are priced in for the eurozone in 2026 and almost one more for 2027. In the US, all rate hikes have been priced out and a rate hike is now priced in with some probability. It is becoming clear that markets expect the inflationary shock to be more than just temporary.
Fed interest rate expectations
The Fed published its new interest rate expectations (“dot plots”) on 18 March 2026. It is unclear exactly when each member formed their expectations and to what extent the current shock is reflected in these expectations. Nevertheless, it is clear that the Fed’s expectations – in contrast to market expectations – remain largely unchanged.
Figure 4: Fed dot plots
Credit spreads: The storm after the calm
Credit spreads had already risen in February in anticipation of the impending escalation. When the war then broke out, however, the credit markets initially reacted calmly. After a week of war, credit spreads were virtually unchanged. In line with the changing assessment of the interest rate markets, investment-grade (IG) credit spreads also rose noticeably, as can be seen in Figure 5:
Figure 5: IG credit spreads
Initially, credit spreads in Europe and the US rose in tandem. Towards the end of the month, however, USD spreads decoupled and moved against the trend, falling, whilst in Europe a further rise was recorded. This is likely due to Europe’s greater energy dependence on global markets.
A look at the sector picture reveals a mixed pattern in the US and Europe in March.
Figure 6: Sector changes since the start of the war
In addition to the consequences of the war, problems in the software sector and in the private debt and private equity sectors are also evident in the US. Financial and IT stocks have recorded the largest spread widening. The outperformance of the energy sector is also striking, with many companies benefiting from higher commodity prices.
Outlook
The Iran conflict has shaken the markets out of their lull. Interest rates and credit spreads are rising, with the latter having moved significantly away from their lows, particularly in Europe. Oil prices continue to rise and volatility remains high. Whilst the political outlook remains unclear, one thing is certain: in such an environment, active portfolio management and rigorous risk control are more valuable than ever.
