Market commentary bonds: Yields up, spreads resilient

In the second quarter of 2026, the Iran war moved from its kinetic phase, with daily missile attacks, into a blockade phase following a formal ceasefire. The US imposed a blockade on Iranian ports in an attempt to bring the country to its economic knees. Iran closed the Strait of Hormuz to ships from countries that had supported the war.

The global economy is currently in a particularly fragile transition phase. The closure of the Strait of Hormuz initially led above all to a sharp rise in energy prices, without immediately affecting real economic activity. For now, inventories, strategic reserves and existing supply chains are still cushioning the impact.

However, it is precisely this apparent stability that carries risks: it masks the fact that global inventories are steadily being depleted and that the adjustment is increasingly shifting from a price problem to a supply problem. While crude oil markets have so far still benefited from high inventories and rerouting options, early signs of physical shortages are already emerging in jet fuel, diesel, natural gas and fertilisers. This increases the risk that the price signals seen so far could turn into actual supply bottlenecks.

A prolonged blockade of the Strait of Hormuz could therefore trigger far-reaching and non-linear consequences for the global economy. Once critical inventories, particularly of diesel and other refined energy products, reach minimum operational levels, rationing, production stoppages and disruptions along global supply chains could follow. The impact would then spread far beyond the energy sector: transport capacity would be restricted, industrial value chains disrupted and the supply of intermediate products, from plastics to fertilisers, strained.

As modern economies rely on tightly synchronised supply networks, even limited bottlenecks can cause disproportionately large production losses. The current stability of the global economy is therefore less an expression of resilience than the result of dwindling inventories. Should the Hormuz blockade persist, there is a risk of an abrupt transition from elevated prices to a global scarcity and recession dynamic.

This insight is presumably the reason why US President Trump gave in to Iranian demands and signed a Memorandum of Understanding (MoU), which was widely perceived as an Iranian victory. Whether this will permanently end the supply chain problem and lead to a broad restoration of goods flows in a few months’ time remains to be seen. The success of the agreement depends not only on implementation by the erratic US President. Other parties, such as Israel, the UN Security Council, the International Atomic Energy Agency and, not least, the US Congress, must also contribute to the success of the agreement. It is therefore too early to declare the conflict over. However, recent developments are moving in the right direction to bring an end to the destruction and prevent a collapse of the global economy and inflation rates spiralling out of control.

Inflation expectations are falling, yields remain high

The ceasefire in the Middle East was welcomed by markets, and risk assets staged a rally. Yields, however, continued to rise, albeit at a slower pace than in March. Only the announcement of the MoU led to a slight recovery on the rates side.

As the figure shows, yields reached their peak in mid-May and showed a certain downward trend only in the second half of the quarter in Europe. This market movement reflects expectations of a higher yield path for central banks, which had already manifested itself in an ECB rate hike in the second quarter.

Interestingly, inflation expectations had already fallen sharply following the ceasefire in early April, as reflected in breakeven inflation rates.

Breakeven inflation rates are the inflation levels that bring the yields of conventional and inflation-linked government bonds of the same maturity to the same level. As the figure shows, one-year inflation expectations fell dramatically at the beginning of April and, by the end of June, were noticeably below their level at the start of the year. Five-year inflation expectations also recorded a significant decline and most recently returned to their level at the beginning of the year.

ECB hikes, Fed waits

The rise in inflation rates prompted the ECB to raise interest rates, while the US central bank, under its new Fed Chair Kevin Warsh, was unable to bring itself to change rates. However, in the latest projections of the future interest rate path published in June, Fed members now see higher rates over the short and medium term than they did three months ago, as shown in Figure 3.

For December 2026, Fed members now anticipate one and a half additional rate steps above the previous expectation. This difference amounts to two rate steps by the end of 2027 and one step in 2028. The Fed’s current view of the future interest rate path has clearly been influenced by the higher inflation effects following the US war of aggression against Iran.

Credit spreads defy economic risks

In contrast to the interest rates markets, credit spreads moved in line with other risk assets and, from the beginning of April, staged a sustained rally following the provisional ceasefire between the US/Israel and Iran.

Despite the risks to the global economy, credit spreads held up strongly in the second quarter. The USD investment grade index fell by 20 basis points to the level seen at the start of the war, while spreads on euro-denominated bonds tightened by as much as 25 basis points and are also trading close to their lows for the year. Once again, the defensive nature of high-quality corporate bonds became evident in an environment in which government bonds are increasingly perceived as risky due to high debt levels, weak growth and erratic political decisions.

Carry and Low Risk lead factor performance

The current market environment, characterised by an ongoing rally, has affected the risk premia available in the corporate bond market in different ways. While the carry factor benefited disproportionately from the spread rally, quality was naturally the weakest factor in such an environment.

• Carry: Due to the ongoing rally in credit markets, carry was the best factor over each of the periods mentioned.
• Equity momentum: Bonds issued by companies with strong equity performance were unable to beat the market and delivered returns slightly below the market average. This was partly due to the divergence between equities and bonds in the IT sector.
• Low risk: Bonds with above-average quality and, at the same time, short duration were able to benefit from rising rates and clearly outperformed the market.
• Quality: Quality companies, with their low risk premia, performed particularly weakly in the rally environment of the past two and a half years.
• Value: Undervalued bonds were able to translate part of their catch-up potential into higher returns.

Conclusion: Corporate bonds as a stabilising factor

While markets are already looking beyond the Iran war, significant risks remain – both with regard to the actual implementation of the MoU between the US and Iran and the full restoration of the flow of raw materials and products from the region. Although fixed income markets have stabilised at a higher level than before the start of the war, other risk assets are not pricing in any major disruption to the global economy.

In this environment, corporate bonds have once again proved to be a safe haven. Bonds with higher risk premia, short duration and attractive valuations benefited disproportionately. Which assets will be the winners in the months ahead will depend above all on further economic developments.

Definition: Quoniam’s research factors

The above analysis refers to Quoniam’s research factors, which are defined as follows:

• “Carry” is the option-adjusted credit spread of the respective bond.
• “Value” is the residual of a regression defined approximately as in Henke, Kaufmann, Messow and Fang-Klingler (2019).
• “Equity momentum” is defined as the 12-month return of the company’s equity. In order to smooth daily price movements, a five-day smoothing period is applied to the share price around the start and end points of the calculation period.
• “Quality” is the measure defined in Piotroski (2000).
• “Low risk” is defined as 50% of the quality measure and 50% of the inverse of the bond’s modified duration, representing a combination of credit risk and interest rate risk.

All factor portfolios from which factor performance is calculated are defined as long-short portfolios, with each bond’s factor score used as a weighting factor. All factors are standardised by month, super-sector (financial versus non-financial bonds) and currency area. All returns are hedged in euros.

Sources:
Henke, H., Kaufmann, H., Messow, P., Fang-Klingler, J. (2019). Factor Investing in Credit. The Journal of Index Investing, 10(3), 7–23.
Piotroski, J. D. (2000). Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Journal of Accounting Research, 38, 1–41.