Bond Markets Signal Fed Rate Hikes as Energy Crisis Deepens

Markets Flip Expectations on Federal Reserve Policy

Bond traders have dramatically shifted their expectations, now pricing a 50% chance of a Federal Reserve interest rate hike by October as concern mounts that a protracted war in the Middle East could stoke global inflation. Money markets no longer see any chance of a Fed rate cut this year, having fully priced in two quarter-point cuts before the US attacked Iran on February 28.

A selloff in the $31 trillion market on Friday sent yields higher by 12 to 15 basis points across maturities after the Wall Street Journal reported that the US is sending three warships and more Marines to the region. The five-year Treasury yield broke above 4% for the first time since July, and the benchmark 10-year Treasury yield surged over 11 basis points to 4.375%, reaching its highest level since August.

Global bond yields have risen to the highest since May 2024 as a surge in energy costs due to the Middle East conflict leads traders to position for central bank interest-rate hikes. The German 10-year rate rose seven basis points Friday to 3.03%, the highest since 2011, while the equivalent UK yield exceeded 5% for the first time since 2008.

Energy Shock Drives Inflation Fears

The conflict caused immediate volatility in energy markets, with Brent crude oil prices surging to around $80–82 per barrel initially, then soaring to nearly $120 per barrel, close to its highest point of $147 recorded in July 2008. The average price for a gallon of regular gasoline is $3.84, up from $2.92 this time last month.

Following the closure of the Strait of Hormuz on March 4, 2026, oil and LNG exports were stranded, causing Brent Crude to surge past $120 per barrel and forcing QatarEnergy to declare force majeure on all exports. Roughly 20 million barrels per day of crude oil and oil products moved through the strait in 2025, as did roughly one-fifth of global liquefied natural gas trade in 2024.

Fed Chair Jerome Powell told reporters that "in the near term, higher energy prices will push up overall inflation; however, it is too soon to know the scope and duration of the potential effects on the economy." Mark Zandi, chief economist at Moody's, warned that "consumers threaten to be hammered by the surge in oil prices," predicting gasoline could reach $4 per gallon if oil prices stay near $100 per barrel.

Central Banks Grapple with Policy Dilemma

The Fed, European Central Bank and the Bank of England all held rates steady this week as policymakers grapple with the uncertain consequences for inflation and growth arising from the conflict in the Middle East, but officials are signaling to markets that they are ready to act soon if necessary to contain inflationary pressures.

The ECB will need to consider hiking interest rates as soon as next month if price pressures build further due to the Iran war, Governing Council member Joachim Nagel said Friday. BOE Governor Andrew Bailey said policy must "respond to the risk of a more persistent effect on UK CPI inflation" from energy prices.

The war is raising concerns about "the impact that it has on global oil markets and the potential for higher energy costs and high fertilizer costs to feed into every production chain and push inflation higher," with inflation "tying the hands of central banks" and making it harder for them to lower interest rates.

Economic Outlook Darkens

Economists have increased projected inflation rates for 2026 as a result of the war, with many citing an increased risk of stagflation. Fears of stagflation – rising inflation and rising unemployment, which major oil shocks have historically summoned – are rising, with economists pointing to the crises of 1973, 1978 and 2008 as evidence that every significant spike in oil prices has been followed by a global recession.

What begins as a battlefield shock hardens into a geoeconomic one, with global inflation expected to rise above pre-conflict forecasts while growth falls short if oil prices remain elevated. In an energy-supply shock, the Fed is likely to avoid big, sudden interest rate moves, instead favoring smaller changes while watching incoming data, as tightening monetary policy to fight inflation can also slow growth and hiring.

The dramatic reversal in market expectations reflects how quickly geopolitical shocks can reshape monetary policy landscapes. What seemed like a year of potential rate cuts has transformed into preparation for higher borrowing costs, leaving consumers and businesses to navigate an increasingly uncertain economic environment.