Bond market sell-off accelerates amid investor fears of stagflationary shock from higher oil prices

Global government borrowing costs have surged as fears of an inflation shock from the Iran war grip financial markets, with bond yields from Tokyo to Washington hitting multi-year or record highs. The sell-off, which accelerated last week, shows no sign of abating, driving up the price governments must pay to borrow and raising the spectre of a prolonged period of higher interest rates.

Benchmark 10-year US Treasury yields jumped to 4.6310% this morning, their highest since February 2025. In Japan, the 30-year government bond yield hit a record 4.200%, while the 10-year yield reached 2.800%, its highest since October 1996. The moves reflect a market bracing for central banks to either raise rates or abandon hopes of cuts as energy-driven inflation ripples through the global economy.

European debt also suffered: 30-year UK gilt yields touched levels last seen in 1997, and 10-year gilts their highest since 2008. German 30-year yields returned to 2011 levels. The rout is not limited to government paper. The FTSE 100 index of blue-chip UK shares dropped to a six-week low of 10,151 points, a fall of 0.4%, with housebuilders among the biggest losers on concern that higher interest rates will hit mortgage demand. Energy stocks bucked the trend, with BP and Shell rising 2.2% and 1.7% respectively as the oil price climbed. Germany’s DAX index also fell almost 0.5% at the open.

Oil price surge and the Strait of Hormuz closure

At the heart of the inflation alarm is the effective closure of the Strait of Hormuz, a chokepoint through which approximately 20% of the world’s seaborne oil and a significant share of liquefied natural gas pass. The strait has been largely shut since late February 2026, following coordinated US and Israeli airstrikes on Iran. Maritime traffic has plummeted, with more than 150 tankers anchored outside the strait, avoiding the risk of attack. The disruption is considered the largest to world energy supply since the 1970s and the biggest in the history of the global oil market.

Brent crude oil rose 1.77% today to $111.16 a barrel, its highest in nearly two weeks, after having already breached $100 in early March and peaked at $126. Some analysts warn prices could reach $200 if the conflict continues. The impact is being felt well beyond the pump. Commodities such as aluminium, fertiliser and helium are also facing supply disruptions; urea prices have jumped 50%, threatening the spring planting season.

Anxiety intensified over the weekend after a drone strike near the Barakah Nuclear Power Plant in the United Arab Emirates caused a fire in an electrical generator. The UAE condemned the attack as a “dangerous escalation” and an “unacceptable act of aggression”. No injuries or radiation leaks were reported, but Tony Sycamore, analyst at IG, said the incident served as “a pointed warning: any renewed US or Israeli strikes on Iran could quickly trigger more proxy assaults on Gulf energy and critical infrastructure”. Saudi Arabia also reported intercepting drones entering its airspace from Iraq.

The oil price jump has “exacerbated fears about a stagflationary shock”, said Jim Reid of Deutsche Bank, noting that bond yields have moved in lockstep with crude over the conflict. He pointed out that 30-year US yields hit their highest since 2007, 30-year Japanese yields their highest since their introduction in 1999, and 30-year German yields returned to 2011 levels. “If you zoom in a bit, yields have shifted from being broadly in line with the current price of oil to looking a bit high relative to it,” he added, suggesting a small decoupling on Friday as markets reassess the outlook.

Central banks face a dilemma

Analysts at ING warned that even if the war ended tomorrow, energy prices might not fall as far as many expect. “Significant drawdowns in oil inventories are likely to keep upward pressure on prices for some time yet,” they said, adding that natural gas prices currently look too low, with meaningful upside risk if disruptions persist into the third quarter as competition intensifies between Asian and European buyers for LNG. “It’s a reminder that, for all the political noise, it’s energy prices that will remain the dominant force for central banks,” they concluded. ING now expects the Bank of England and European Central Bank to raise rates in June, and no longer forecasts a Federal Reserve rate cut until December.

ECB rate-setters have signalled a likely hike in June, though some reports suggest certainty is diminishing because oil price spikes have been less severe than initially feared. The Bank of England’s next decision is due on 18 June; deputy governor Sarah Breeden has indicated that rate hikes are not needed in June or July, but left the door open. Goldman Sachs has pushed back its forecast for Fed cuts to December 2026 and March 2027, citing sticky inflation and a resilient jobs market. The Fed held rates steady in April 2026 with a divided vote, and traders now expect no change through the end of the year.

Chris Beauchamp, chief market analyst at IG, said the combination of political turmoil and renewed gains for oil had been “kryptonite for hopes of a new FTSE 100 rally”. He added: “The selling has not been confined to the UK… The market rally is rapidly coming to grips with the reality of the situation in the Middle East and in the global oil market, and it is not going to be pretty.”

China data adds to growth concerns

Weak economic data from China compounded the gloomy mood. Factory output growth slowed to 4.1% year-on-year in April, down from 5.7% in March, according to the National Bureau of Statistics, despite a jump in exports as customers stockpiled goods to avoid supply disruption. Retail sales growth decelerated to just 0.2% — the weakest reading since December 2022 — from 1.7% in March. Fixed-asset investment fell 1.6% year-on-year in the January–April period, compared with a rise of 1.7% in January–March. Lynn Song, ING’s chief economist for Greater China, said the figures suggested “a steep drop-off of investment in April as geopolitical uncertainty may have weighed on investment decisions”. The data points to a sharp deceleration in the second quarter after the first quarter comfortably beat expectations.

The impact of high oil prices is especially acute for import-dependent economies. India, which imports 88% of its crude oil, much of it through the Strait of Hormuz, saw its crude oil basket nearly double in March. Inflation there is projected to reach 5–6% in the second and third quarters of 2026.

Political turmoil adds to pressure

The global bond sell-off comes at a particularly sensitive time for the UK, where a leadership crisis is gripping the Labour government. Yields on 30-year UK debt hit their highest since 1998 last week as Keir Starmer’s premiership faltered and likely challenger Andy Burnham moved to return to parliament via a by-election in Makerfield. Losses were fuelled by warnings that a change of leader might shift fiscal policy towards higher spending and borrowing, loosening the fiscal rules designed to reassure bond markets. Over the weekend, however, Burnham told ITV: “I support the fiscal rules, there needs to be a plan to get debt down.” That pledge may provide some support for UK bonds today.

In Japan, Prime Minister Sanae Takaichi said she had told finance minister Satsuki Katayama to begin work on a supplementary budget to cushion the impact of the Middle East conflict. According to Reuters, the extra budget will focus on funding subsidies to curb gasoline and utility bills, as surging oil prices cloud the outlook for an economy heavily reliant on fuel imports from the region. The prospect of new debt issuance adds further upward pressure on Japanese bond yields.

G7 finance ministers meeting in Paris on 18–19 May will discuss the situation in bond markets. French finance minister Roland Lescure described the sell-off as a “correction rather than a collapse”, but added: “We are no longer in a period where public debt is not a subject.”

Lale Akoner, global market strategist at eToro, said the move higher in yields suggests markets are “increasingly accepting a ‘higher-for-longer’ interest rate environment”. She warned that “higher yields do not stay confined to bond markets… they can weigh on equity valuations, particularly in growth and technology sectors, while also increasing pressure on governments carrying large debt burdens.” Rising oil prices and fears of disruption around the Strait of Hormuz are reviving inflation concerns at a time when many central banks had hoped price pressures would continue easing. “For now, bond markets appear to be signalling that investors should prepare for a more volatile environment where higher borrowing costs remain a key market theme well into the second half of the year,” she said.