The Bond Market’s Broken Playbook

When the United States launched military operations against Iran on February 28, the conventional response for bond investors is to buy. Geopolitical uncertainty historically drives demand for U.S. Treasuries as a safe haven, pushing prices up and yields down. That is not what happened. The 10-year Treasury yield has risen from below 4% before the war to 4.118% as of March 5. The 2-year note rose a further 2.5 basis points today to 3.567%. Tim Baker, macro strategist at Deutsche Bank, stated that Treasuries are showing no signs of safe-haven demand.

To understand why, the analysis has to begin not with the war itself but with what the war does to energy markets — and what energy markets do to inflation expectations and Federal Reserve policy. The transmission chain from conflict to bond yields runs through oil, and that chain explains why the assets that are rising (oil, gold, the US dollar, defence stocks) are different from the assets that normally rise in a geopolitical crisis.

FIGURE 1  Safe-Haven Divergence Since the Iran Conflict Began.  Gold rose to $5,335/oz while the 10-year Treasury yield simultaneously climbed from 3.97% to 4.118% — the inverse of the normal geopolitical-crisis pattern. Both series accelerated at the Feb 28 war start date. Source: ClaudeFinance Research, March 5, 2026.

The Energy Shock: Strait of Hormuz and the Oil Price Surge

The Strait of Hormuz is 21 miles wide at its narrowest point and carries approximately 20 million barrels of oil per day — roughly 20% of global daily supply. Saudi Arabia, the UAE, Kuwait, Iraq, and Qatar all export the majority of their crude through it. There is no adequate alternative route for most of that volume. Iran borders the Strait on its northern shore.

On the first day of the conflict, Iran announced it had closed the Strait to commercial shipping and would target any vessel attempting to pass through. Whether that closure is fully enforceable is contested — the U.S. Navy has substantial assets in the region — but the announcement alone was sufficient to move markets. Brent crude surged as much as 13% in overnight trading on February 28 before partially easing. By March 3, Brent had risen more than 15% from its pre-war level near $70, reaching $83.79 per barrel.

The Strait closure threat does not need to be fully enforced to affect prices. The risk premium enters oil markets the moment the threat is credible, and it stays there until either the conflict ends or U.S. naval protection is demonstrably effective.

The Trump administration has taken concrete steps to address the shipping risk. Treasury Secretary Scott Bessent stated on March 4 that the U.S. would make a series of announcements to stabilise oil flows through the Persian Gulf. President Trump separately offered maritime risk insurance to tankers willing to transit the route. These assurances moderated the initial spike but did not eliminate the underlying risk premium. Energy strategists have warned that a sustained Strait closure could push oil above $100 per barrel. The gap between $83.79 and that threshold is the market’s current assessment of disruption probability.

It is also worth noting that the enforceability question cuts in both directions. If U.S. naval assets successfully protect transit, the oil shock is limited and temporary. If a tanker is successfully struck, the risk premium resets sharply higher. That binary — naval protection holds or fails — is the single most important unresolved variable in the energy trade right now.

From Oil to Inflation to Yields: Why Bonds Are Selling Off

Higher oil prices do not stay in energy markets. Every $10 per barrel increase in Brent crude adds approximately 0.2 to 0.3 percentage points to annual U.S. CPI over a six to twelve month horizon, according to Federal Reserve research. The 15% surge in Brent since February 28 represents roughly a $12 per barrel move. The inflationary impulse is already building. The average U.S. gasoline price jumped 11 cents overnight in the first days of the conflict to approximately $3.11 per gallon. Business input costs are moving in the same direction.

When oil-driven inflation expectations rise, investors reassess the probability and timing of Federal Reserve rate cuts. Before the conflict began, the market was already pushing expected rate cuts further into the future, with sticky services inflation and a resilient labour market removing urgency for the Fed to ease. The oil shock arrives on top of that existing dynamic and pushes rate-cut expectations out further still. The result: investors holding long-dated Treasuries face a longer period of elevated rates than they previously priced, making those bonds less attractive. Prices fall and yields rise.

Two economic data releases this week reinforced the inflation picture before the oil shock had even fully transmitted. The ISM Manufacturing PMI for February came in at 52.4, with the prices paid component — which measures the percentage of manufacturers reporting higher input costs — surging 11.5 points to 70.5. That reading indicated broad factory-level price acceleration already underway before the war began. ADP private payrolls for February then came in above consensus, confirming that the labour market remains tight enough that the Fed cannot justify cutting on growth grounds alone.

This combination — energy shock, pre-existing input price pressure, tight labour market — is the reason Treasury yields are rising rather than falling. It is worth acknowledging that Treasury yields can also rise for other reasons not directly related to this conflict: Treasury issuance and duration supply, shifts in global reserve demand, and term premium expansion driven by fiscal deficit concerns. Those structural factors were already present in the market before February 28 and may be amplifying the move. The inflation channel is the dominant explanation for the speed and direction of the yield increase, but it is not the only one.

Cross-Asset Reaction: Where the Flows Are Going

With the inflation transmission mechanism established, the cross-asset picture becomes analytically coherent. Safe-haven demand has not disappeared — it has redirected. Gold has risen above $5,300, driven by a combination of inflation-hedge demand and crisis-driven haven buying. Gold ETF inflows accelerated in the days following the strikes, and futures positioning shifted net long. The U.S. dollar index gained 0.95%, erasing its year-to-date losses and reaching a five-week high, reflecting both reserve currency demand during uncertainty and the repricing of Fed rate expectations — a stronger case for holding rates supports the dollar. The flight to safety that normally goes to Treasuries went to gold and the dollar instead, because Treasuries are exposed to the same inflation shock that is driving the crisis.

Equities have been volatile but more contained than some initial assessments feared. Goldman Sachs CEO David Solomon described the reaction as more benign than the magnitude of the event would suggest, noting it would take a couple of weeks for markets to fully digest the implications. The S&P 500 fell 0.94% on Tuesday but partially stabilised Wednesday as oil prices eased from their peak. Defence stocks — Northrop Grumman, RTX, and Lockheed Martin — rose 6%, 4.7%, and 3.4% respectively, reflecting elevated military spending expectations that persist regardless of how the conflict resolves. Airlines fell sharply on the dual pressure of rising jet fuel costs and reduced Gulf route demand.

The table makes clear that gold and the dollar, not Treasuries, are functioning as the crisis hedges. That outcome is consistent with the inflation transmission argument: Treasuries cannot absorb safe-haven flows when the inflation risk generated by the crisis is precisely what makes those bonds less valuable.

What History Says About Conflicts and Markets

U.S. equity markets have historically recovered within weeks of the onset of major military operations. The S&P 500 posted double-digit gains in the three to six months following both Gulf War engagements. The pattern reflects a consistent dynamic: initial uncertainty reprices risk downward, but once the operational picture clarifies and energy disruptions prove temporary, liquidity and earnings expectations reassert.

The caveat that applies to every historical precedent is oil. Markets have absorbed military conflicts in the Middle East relatively quickly when oil disruptions were limited or short-lived. The 1973 Arab oil embargo — which produced a genuine, extended energy shock — was the significant exception: it generated sustained stagflation and a prolonged equity bear market. The current conflict does not yet approach that scale, but the Strait of Hormuz risk is the mechanism that could make the current situation more disruptive than the historical baseline suggests.

Morgan Stanley has flagged two specific second-order effects worth monitoring. First, if oil stays elevated for several months, the year-on-year CPI trajectory could reverse the disinflation progress the Fed has achieved since 2023, reducing the scope for rate cuts and compressing equity valuations. Second, elevated energy prices slow household consumption — higher gasoline and utility bills leave less disposable income for other spending, which flows through to retail, consumer discretionary, and eventually earnings. Those effects take two to three quarters to appear in earnings reports, which means markets are currently pricing them with limited information.

The Federal Reserve’s Position and Friday’s Key Data

The Fed enters this conflict in a holding posture that the oil shock makes more difficult to exit. Before February 28, the case for cutting rates was already weak: services inflation remained sticky, the labour market was adding jobs at a pace inconsistent with significant slack, and the ISM prices paid component was already rising. The oil shock now adds an external inflationary impulse on top of those domestic factors.

The central bank faces two plausible scenarios, and they require opposite responses. In the first — which might be called the short-conflict scenario — the war resolves within Trump’s stated four to five week timeline, the Strait is reopened under U.S. naval protection, oil retreats, and the inflation impulse is temporary. In that case the Fed can continue its gradual approach to rate normalisation, and any temporary CPI increase is looked through. In the second scenario — a prolonged conflict with persistent Strait disruption — oil stays elevated, CPI rises, and the Fed faces rising inflation at the same time that consumer confidence and business investment are weakening. Cutting into that environment risks accelerating inflation. Holding or raising risks deepening the growth slowdown.

The Fed does not yet know which scenario it is in. Neither does the market. Friday’s Nonfarm Payrolls report is the last major data point before the March meeting, and it arrives with more analytical weight than any single jobs report has carried in months.

The consensus for February’s NFP is approximately 170,000 jobs added, a notable step down from January’s 256,000. A print below 130,000 would introduce a genuine growth concern — giving the Fed a credible justification to cut even against an inflationary backdrop — and would likely pull Treasury yields back. A print at or above 200,000 would cement the hold case, reinforce the inflation narrative, and push yields higher.

The Synthesis: Four Variables That Resolve This

The Treasury selloff since February 28 reflects a coherent set of market judgements, not a malfunction. Oil prices have risen because the Strait of Hormuz risk is real. Rising oil prices have reinforced inflation expectations that were already elevated by domestic data. Elevated inflation expectations have pushed the timing of Federal Reserve rate cuts further into the future. Longer-dated Treasuries are repriced lower as a result. Gold and the dollar have absorbed the safe-haven demand that Treasuries cannot receive while they are themselves exposed to the inflation risk.

Both an inflation shock and a growth shock can coexist in a prolonged conflict — the distinction is not absolute, and the balance between them shifts depending on how long the Strait disruption lasts and how the labour market responds. The current data favours the inflation case. If the growth picture deteriorates materially, that assessment changes.

Four variables will determine how this resolves. The oil price: sustained below $90 per barrel, the inflation impulse is manageable within existing Fed models; above $100, the calculus changes. The Strait of Hormuz: whether U.S. naval protection is demonstrably effective over the next two weeks determines whether the risk premium in oil stays or collapses. Friday’s NFP: a weak print reopens the rate-cut debate despite inflationary pressure; a strong print closes it. The conflict duration: Trump’s stated four to five week timeline is the baseline; an extension of that timeline extends the oil shock and all of its downstream effects.

Until those variables resolve, the cross-asset positioning implied by the current environment is internally consistent: exposure to assets that benefit from persistent inflation — energy, gold, dollar, defence — and caution toward assets that are repriced by a combination of higher energy costs and delayed rate cuts.

Disclaimer: This article is for informational and educational purposes only and does not constitute investment advice or a solicitation to buy or sell any security. All data referenced reflects publicly available information as of March 5, 2026. Investing involves substantial risk including the potential loss of all capital. Always consult a licensed financial advisor before making investment decisions.