Middle East Conflict Triggers Global "Deficit Panic": 30-Year US Treasury Yield Approaches 4.9%

Concerns over fiscal spending triggered by the US-Iran conflict are sweeping through global bond markets, with long-term government bonds experiencing a new round of selling.

On Friday, the 30-year U.S. Treasury yield rose to nearly 4.90%, hitting a one-month high. Since the outbreak of the war on February 28, this yield has increased by over 20 basis points, erasing all of this year’s gains in U.S. Treasuries. The Bloomberg U.S. Treasury return index has nearly returned to zero for the year.

This sell-off is not unique to the United States. From the UK to Germany, from Australia to Japan, global bond yields are soaring across the board, with long-term government bonds generally under pressure.

Investors are worried that as war costs continue to rise, governments will have to borrow heavily to fund defense spending and support households hit by energy price shocks. This outlook, combined with inflationary pressures from rising oil prices, poses a dual threat to the fixed income market.

Dual Pressures of Fiscal and Inflationary Challenges Hit the Long End

The rise in long-term yields is driven by two forces: inflation expectations and concerns over fiscal deterioration.

Notably, the 30-year inflation-protected securities (TIPS) yield has increased by 7 basis points this week—while short-term real interest rates have fallen due to expectations of slower growth—this divergence indicates that market worries about long-term fiscal sustainability have gone beyond mere economic cycle considerations.

“Long-term rates are a story about fiscal policy and government credibility,” said Gang Hu, Managing Partner at Winshore Capital Partners. “They reflect market expectations that Trump will need to spend money to pay for the war and to subsidize consumers coping with high oil prices.”

Currently, the U.S. Congress is discussing up to $50 billion in additional war funding, but the government has not yet released specific estimates of military costs. Meanwhile, the U.S. budget deficit remains around $1 trillion over the five months ending in February, and a Supreme Court ruling overturning trade tariffs has suddenly eliminated a source of hundreds of billions of dollars in revenue.

“This occurs at a point where tariff revenues are reversing, and tariffs themselves are inflationary, as is war,” said Matt Eagan, Portfolio Manager at Loomis, Sayles & Co., which manages over $430 billion in assets. “This will only worsen the deficit.”

The auction of $22 billion in 30-year U.S. Treasuries on Thursday saw decent demand after yields surged, but market participants are not optimistic about the outlook. “Before yields break 5%, I see no attraction in 30-year Treasuries,” Eagan added.

Global Borrowing Surge, Bond Market Pressure Spreading Abroad

Fiscal pressures are not limited to the U.S. In Europe, governments are facing dual pressures of higher defense spending and potential energy subsidies. European Commission President von der Leyen proposed several measures this week, including a cap on natural gas prices. According to Andrzej Szczepaniak, Senior European Economist at Nomura Securities, European governments may replicate the response during the 2022 energy crisis by issuing joint EU bonds to finance crisis-related expenditures, which could create structural pressure on eurozone bond markets.

Asia is also feeling the strain. Countries like Australia and Singapore have already increased defense budgets, and Japan’s defense spending this year is expected to hit a record high. Carol Kong, Strategist at Commonwealth Bank of Australia, pointed out that the Iran conflict could further elevate long-term expenditure pressures for Asian governments, complicating fiscal consolidation efforts. “Rising inflation expectations will also push bond yields higher, and Asia, including Japan, is no exception.”

Chris Arcari, Head of Capital Markets at Hymans Robertson, noted that compared to the energy crisis triggered by the Russia-Ukraine conflict in 2022, governments currently have less fiscal space, with higher debt burdens and interest costs. The bond market may be less willing to finance such large-scale fiscal expansion this time, or at least will demand higher real yields as compensation.

Investors generally believe that if the conflict persists and governments continue to increase spending, the ongoing expansion of global bond supply will keep long-term rates under pressure. Requiring higher risk premiums for long-term bonds may become the new normal.