BlackRock's Investment Institute has stated that government bond yields will remain elevated for an extended period due to persistent inflationary pressures exacerbated by the conflict in Iran. Strategists, including Jean Boivin and Wei Li, wrote in a report that inflationary pressures were already building before the recent Middle East conflict erupted. The war-induced oil shock has only intensified these risks, increasing pressure on central banks to maintain tight monetary policies to curb price rises. This is unfavorable news for sovereign bonds, as inflation tends to erode the fixed coupon payments of bonds, diminishing their real returns and reducing their appeal as a hedge against high-risk equities. BlackRock has chosen to maintain an "overweight" rating on U.S. and emerging market stocks, betting that the rapid expansion of artificial intelligence will boost returns. The Iran conflict has prompted a reassessment of interest rate expectations by hawkish policymakers. They wrote, "We believe high yields are here to stay, and long-term government bonds are no longer an effective diversification tool to protect against stock market declines." BlackRock's comments come during a rare "super central bank week," with all G7 central banks holding meetings to decide monetary policy for economies accounting for about half of global GDP. Although traders expect central banks to keep interest rates unchanged, they will closely monitor whether officials express concern over inflation threats stemming from potential severe disruptions to crude oil supplies caused by the conflict. Sovereign bond yields reflect these concerns. Since the start of the war, the yield on the 10-year U.S. Treasury note has risen by approximately 40 basis points. Yields on the more policy-sensitive two-year Treasury notes have also increased. Strategist Mark Cranfield noted that bond traders see central banks in a difficult position this week, as they attempt to balance short-term inflationary impacts from high energy prices against long-term risks of slowing economic growth. Meanwhile, global stock markets have recouped losses incurred due to the war, partly driven by a rebound in artificial intelligence-related trading. BlackRock strategists wrote, "In this environment, we maintain a risk-on stance. The conflict is strengthening the resolve of governments worldwide to invest in energy security and defense, which will add to heavy debt burdens and create upward pressure on inflation." The firm's analysts stated that this is why they favor equities over bonds, while also highlighting thematic investment opportunities in the power and infrastructure sectors, driven by AI demand and energy security initiatives.
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