Escalation of US-Iran conflict, Strait of Hormuz in crisis: How will the fixed income market react?

On February 28, 2026, the US and Israel launched a full-scale military strike against Iran, with President Trump explicitly setting regime change as the goal of the operation. Regional conflict escalated rapidly, followed by retaliatory attacks from Iran on multiple Gulf nations including Dubai, Abu Dhabi, Doha, and Bahrain. More critically, the Strait of Hormuz — a strategic waterway only 21 miles wide that handles about 30% of global seaborne crude oil and 20% of liquefied natural gas transportation — has effectively come to a halt in commercial navigation.

This week's market movements

US Treasury bonds: As of March 4, the entire US Treasury yield curve trended upward, with short-term yields under significant pressure due to delayed expectations of Federal Reserve rate cuts, showing more pronounced increases, while long-term yields remained relatively resilient supported by geopolitical risks and inflation expectations. The overall curve showed a bear flattening trend, with both the 2s10s spread and the 10s30s spread widening compared to last week.

Middle East sovereign bonds: Rising geopolitical risk premium coupled with climbing US Treasury yields exerted dual pressures on regional credit bond markets. This week, Gulf IG sovereign bonds, including those of Saudi Arabia, the UAE, Qatar, and Israel, saw price declines, while their 5-year CDS widened to varying degrees. Risk premiums in the region’s high-yield market surged even more dramatically. The 5-year CDS of Egypt and Turkey soared, indicating a sharp rise in market concerns over their credit risks.

Market Outlook

Time is a key variable:We believeThe duration of the conflict is the core variable determining market direction. If the war ends within the next two weeks, its impact on the capital markets will be temporary, with risk premiums gradually retreating and markets returning to fundamentals-driven trends. However, if the conflict persists for a longer period, compounded by the continued closure of the Strait of Hormuz, markets will face extreme uncertainty, potentially triggering a series of chain reactions.

Energy Market:We believeOil and natural gas prices will continue to rise, and the long-term supply landscape may undergo profound changes.According to JPMorgan's equilibrium model estimates, if oil supplies through the Strait of Hormuz are reduced by approximately 4 million barrels per day, Brent crude prices could easily exceed $100 per barrel. If the disruption lasts more than three weeks, depleting Gulf Cooperation Council inventory buffers, oil prices might soar to between $100 and $120 per barrel. However, in the long term, turmoil in the Middle East may force Europe to reconsider its energy supply sources, potentially leading to a loosening of the energy embargo on Russia. At the same time, Asia's long-term supply structure could also change, possibly turning to Europe or Latin America to reduce dependence on Middle Eastern oil. In the short term, natural gas and liquefied natural gas face greater upward pressure, mainly due to Europe’s currently low natural gas inventories and the heavy reliance on transportation through the Strait of Hormuz.

Interest rate:If oil prices remain high over the next one to two quarters, it could bring significant inflationary pressures. A sharp spike in oil prices may trigger notable demand contraction, with emerging markets being particularly affected. However, amid constrained supply, economies could face stagflation risks—slower economic growth coupled with rising inflation, increasing the risk of higher interest rates, which could directly impact the pace of Federal Reserve rate cuts. This week, US Treasury yield curves moved up across the board, especially at the short end, driven by expectations of delayed rate cuts, reflecting market pricing of this risk. We expect thatif oil prices remain elevated, the Federal Reserve may be forced to delay rate cuts, or even reassess its monetary policy stance, further pushing up short-term yields.

Credit bonds:We believeit is crucial to distinguish between short-term fluctuations and long-term trends at present.The impact of commodity price movements on corporate fundamentals takes at least several months to materialize, so most of the current spread volatility seen is primarily driven by market trading rather than fully reflecting substantive changes in fundamentals. From a valuation perspective, investment-grade credit spreads are currently at historically low levels, offering thin margins of safety; we maintain a cautious stance in the long term. If the conflict persists against a backdrop of continuously rising energy prices, US and Asian oil and gas exploration and production companies, as well as European integrated energy giants, may benefit, given their robust balance sheets and low exposure to geopolitical risks. Meanwhile, rising energy costs will erode corporate profits, with Asian refineries, automobile manufacturers, and global logistics industries facing immense operational and financial pressures amid the current geopolitical tensions. Additionally, Asian refineries will see significantly compressed profit margins due to soaring VLCC freight rates.

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