International bond markets experienced dramatic swings throughout May as the Iran conflict continued to create uncertainty among investors, driving borrowing costs to levels not seen in decades before economic concerns brought them back down.
The volatility highlights how sensitive financial markets remain to both inflation worries and mounting government debt burdens worldwide, even as potential diplomatic progress offers hope for stabilization.
TREASURY TURBULENCE
U.S. Treasury bonds faced severe pressure during the month, with 30-year bond yields climbing to approximately 5.2% by May 20 – the highest level recorded since 2007. The $28 trillion U.S. government bond market was shaken by stalled diplomatic efforts that drove oil prices back over $110 per barrel, combined with concerning American inflation figures.
The selloff wasn’t limited to American markets. British bond yields reached their highest points in 20 to 30 years, Japanese yields hit all-time records, and Germany’s 10-year yields climbed to their peak since 2011.
“The market’s concerned that inflation may be here a bit longer than we had anticipated,” explained David Zahn, who serves as Franklin Templeton’s head of European fixed income.
ECONOMIC HEADWINDS
Market conditions shifted as diplomatic talks between the U.S. and Iran showed advancement, causing oil prices to retreat and borrowing costs to decline. Disappointing economic indicators, especially from European nations, also reduced expectations for aggressive interest rate increases.
Data released last week revealed that Euro zone business activity contracted at its steepest pace in two and a half years during May, as the region struggled with escalating energy expenses.
“With this level of yields it’s becoming attractive for an investor,” noted Nicolas Forest, chief investment officer at Candriam. “We have a slowdown of the economy and that’s supportive for the bond markets.”
AMERICAN DIVERGENCE
While energy-dependent economies including the Euro zone, Britain and Japan had previously suffered the most during bond market declines, the United States stood out as the worst performer in May.
American 10-year yields increased by 6 basis points between April 30 and May 29, while German equivalent yields dropped by 6 basis points.
European economic weakness reduced rate increase expectations there, but the American economy maintained its strength, supported by increased artificial intelligence investment spending.
Market participants completely eliminated expectations for any Federal Reserve rate reductions this year and temporarily anticipated a full 25 basis point rate increase by December.
Thursday’s data revealed the Fed’s preferred inflation gauge rose 3.8% annually in April, marking the fastest increase in three years.
BRITISH BOND CONCERNS
May proved particularly challenging for the UK government bond market, which has remained vulnerable to sharp declines since the 2022 crisis during Liz Truss’s tenure.
Thirty-year British government bond yields surged to 5.87% in mid-May, their highest since 1998, as global market turmoil combined with concerns that a potential successor to struggling Prime Minister Keir Starmer might increase government spending.
British bonds later recovered as peace prospects improved, UK economic data weakened, and leading candidate Andy Burnham committed to maintaining the government’s fiscal guidelines.
Between April 30 and May 29, 10-year British government bond yields outperformed both German and U.S. equivalents, falling approximately 21 basis points, though they remain 58 basis points higher since the conflict began.
“If we look at Bank of England pricing, we’ve gone from two cuts at one point to nearly three hikes, so that’s been the main driver (of UK bonds),” said Matthew Amis, investment director at Aberdeen.
“But also in the background the political volatility has clearly not helped.”
LONG-TERM DEBT PRESSURES
Longer-term government debt, which responds more strongly to economic and budget concerns than shorter-term bonds, experienced the heaviest selling during mid-May.
Inflation-adjusted ‘real’ yields also increased in both the U.S. and Europe, demonstrating that price pressures weren’t investors’ sole worry.
Bank of America analysts identified what they called “ever-worsening fiscal dynamics” as a primary factor behind the U.S. Treasury selloff.
Despite the Federal Reserve’s committee-based decision making, some investors expressed concerns about the independence of new Fed Chair Kevin Warsh, who received his appointment from U.S. President Donald Trump.
“Let’s imagine that he decides to cut rates despite higher inflation,” Forest said. “That’s not very supportive for U.S. Treasuries.”
