The Iran-US ceasefire collapses, on top of the US Federal Reserve warning of AI inflation risks, triggering a severe sell-off in the global bond market and pushing US bond yields close to their yearly highs.

Multiple factors such as the reignition of military conflicts between the US and Iran, a sharp rise in oil prices, and the minutes of the Federal Reserve meeting revealing that investments in Artificial Intelligence (AI) are becoming a new inflation threat have impacted the global government bond market, leading to fierce sell-offs. Yields on US Treasury bonds have seen a steady increase, with the two-year yield approaching its 2026 high and the ten-year yield briefly surpassing the 4.6% mark. European bond markets have experienced deeper declines, with long-term interest rates in the UK and Germany seeing significant jumps. The market is now betting aggressively that both the Federal Reserve and the European Central Bank will raise interest rates further within the year. Trump declares end of ceasefire, oil prices soar igniting inflation fears The immediate trigger for the current turmoil in the bond market is the sudden escalation in the situation in the Middle East. During the NATO summit in Ankara, Turkey on Wednesday, US President Trump explicitly stated that the ceasefire between the US and Iran has come to an end. "For me, the agreement is over, I don't want to deal with them anymore," Trump told the media. He then issued further military threats, stating that the US will deal a heavy blow to Iran. Prior to this, Iran had launched a series of attacks on ships near the Strait of Hormuz, to which the US responded by carrying out airstrikes on Iranian targets on Tuesday and attempting to block its legal oil export channels. Iran retaliated promptly. The fragile temporary peace framework was on the verge of collapsing. As a result, international oil prices surged. As of the time of writing, the global benchmark Brent crude oil futures broke through $79, while WTI crude oil futures were trading at $74.30 per barrel. Although oil prices are far below the peak of around $120 per barrel in late March when the US-Iran conflict first erupted, the fragility of the ceasefire has reignited strong concerns in the market about the rise in energy costs driving inflation. Patrick Munnelly, strategist at Tickmill Group, pointed out that the recent attacks near the Strait of Hormuz "have turned the once-faded risk premium back into a real inflation shock." US bond yields surge, repricing the path to rate hikes The anxiety in the commodity markets quickly spread to the fixed income markets. The two-year US Treasury bond yield, which is most sensitive to monetary policy expectations, rose to 4.21%, reaching 4.235% at one point on Wednesday, just shy of the year-to-date (and since February 2025) high of 4.25% set on June 22. The ten-year US Treasury bond yield, which serves as a key benchmark for mortgages, car loans, and corporate debt, also climbed to around 4.58%, briefly surpassing 4.60% during Wednesday's early trading session, the highest level since May 21. The thirty-year bond yield also rose to 5.077%. With the rise in yields, the pricing in the interest rate futures market quickly reversed. Traders are now betting again that the Federal Reserve will end its wait-and-see approach and start hiking rates before October, having previously pushed expectations back to December. According to the CME's FedWatch tool, the market now sees over an 80% probability of a rate hike at the September meeting, with a high probability of at least one rate hike by the end of the year and a 44% chance of multiple rate hikes. Following the release of the minutes from the June Fed meeting on Wednesday afternoon, which was the first meeting chaired by newly appointed chairman Kevin Warsh in May, the market's hawkish expectations were further solidified. The minutes revealed a committee with diverging views on the rate path, but highly vigilant about the upward risks to inflation. The minutes showed that "most participants noted that given the economic activity growth exceeding potential output, partly driven by strong AI business investment, there could be more persistent inflationary pressures." When discussing the potential scenario of high and persistent inflation, "almost all participants mentioned that there might be a need for some policy tightening measures to bring the inflation rate back to 2%." AI emerges as a new inflation concern as massive bond issuance adds supply pressure The most surprising detail in the minutes was the Federal Reserve's emphasis on the potential inflation impact of AI. In the April minutes, "AI" was mentioned only 8 times and only once in connection to inflation, while in the June minutes, "AI" appeared 20 times and was directly linked to the risk of rising inflation on 7 occasions. The minutes warned that while AI may in the long term increase supply and lower inflation by reducing production costs, "this effect may take some time to materialize," and the current fervent investment in AI infrastructure is now ranked alongside tariffs and oil prices as the three main inflation threats facing the Federal Reserve. At the same time, corporate financing for AI investments is directly impacting the bond market's supply. Amazon.com, Inc. launched a massive bond issuance of at least $250 billion on Wednesday to support AI infrastructure development, including a batch of long-term notes maturing in 2036. John Caravan, Chief Analyst at Oxford Economics, believes that this wave of debt issuance competes directly with government debt, further pushing up yields in the US. The US Treasury conducted a $39 billion auction for ten-year bonds on Wednesday, with the bid yield indicating around 4.59%, reaching the highest level for similar auctions since February 2025. However, demand for the two-year bond auction on Tuesday remained robust. European bond markets faced a more intense impact than the US. As the European markets had not yet reacted to the sudden escalation in US-Iran tensions by the end of Tuesday's trading session, they experienced a sharp downturn at the opening on Wednesday. Germany's ten-year bond yield surged by 8 basis points to 3.068%, while the UK's ten-year bond yield spiked by 13 basis points, reaching a high of 4.957%. The shadow of inflation driven by oil is putting pressure on European policymakers as well. The eurozone money markets have fully digested the expectation of a 25 basis point rate hike by the European Central Bank in October. Analysts at KBC Bank emphasized that the rise in oil prices means that the "European Central Bank cannot relax its vigilance for the time being." The UK market has already priced in a 25 basis point rate hike by the Bank of England before November, with a 40% probability of a second rate hike before the end of the year. An analyst at First Abu Dhabi Bank pointed out that regardless, recent events have shown that the memorandum of understanding signed by the US and Iran at the end of June was "merely an agreement to negotiate agreements, not a substantive ceasefire agreement." With the fragile peace framework facing collapse, coupled with the structural inflationary ghost brought about by AI capital expenditures, the calm in the global bond market has been completely shattered. Bryce Doty, bond fund manager at Sit Investment Associates, said, "Bond investors are very cautious. They are worried that the breakdown of the ceasefire will lead to higher energy prices and inflation, and they are also worried that the minutes of the Federal Reserve meeting will fuel the fire." And now, these two major concerns have turned into reality at the same time.