Middle East tensions rise again, triggering inflation concerns; US Treasury bonds sold off, two-year yield climbs to one-week high

According to Zhitong Finance APP, as reports emerged about potential further escalation of conflicts in the Middle East, international oil prices surged rapidly, sparking renewed concerns about intensifying global inflationary pressures. US Treasuries were sold off on Wednesday, with yields across various maturities climbing, particularly in short-term bonds. At the same time, the US dollar strengthened, reflecting investors' reassessment of the potential impact of geopolitical risks on inflation and Federal Reserve monetary policy.

During Wednesday's trading session, the US Treasury market remained relatively calm for most of the time, but around 2:45 p.m. New York time (2:45 a.m. Beijing time on October 22, 2026), the market suddenly saw significant volatility. At that time, West Texas Intermediate (WTI) crude oil futures quickly rose from about $97 per barrel to around $98.50, pushing Treasury yields to intraday highs. The yield on the two-year US Treasury climbed by as much as 5 basis points, reaching 4.83%, the highest level in a week.

Because bond prices move inversely to yields, a rapid rise in yields signals that investors are selling US Treasuries. Meanwhile, major US stock indexes also saw a brief decline, while the dollar strengthened.

This bout of market volatility was mainly triggered by a report concerning the Middle East situation. According to the report, the US is preparing to order some embassy staff to evacuate from the Persian Gulf region. Given the military clash between the US and Iran this past February, this development quickly reignited market worries about the potential for a renewed escalation in the region.

However, as US officials later clarified that the evacuation order only involved Saudi Arabia, market anxiety eased somewhat, and some of the initial price swings driven by the news diminished.

John Briggs, Head of US Rate Strategy at Natixis North America, stated that risks related to Iran have never truly disappeared. If the market again fears escalation of the conflict, global bond yields may once again face upward pressure because rising energy prices will amplify inflation risks and may prompt investors to increase their expectations for central bank policy rates. In fact, since the outbreak of the Middle East war in February, international oil prices have continued to climb, reigniting global inflationary pressures and prompting the Federal Reserve and other major central banks to raise rates.

For the bond market, the impact of rising oil prices is particularly complex. On one hand, geopolitical risks typically drive investors to buy safe-haven assets like US Treasuries; on the other hand, if energy prices continue to rise and worsen inflation, the market may anticipate tighter monetary policy from central banks, boosting yields higher.

Currently, the latter factor is exerting clear pressure on the US Treasury market. Yields remain near multi-year highs reached earlier this month. This comes after robust US economic data, expanding government debt levels, and expectations of further Fed rate hikes have all contributed to rising Treasury yields.

With international oil prices rising again, investors have become more cautious about the Fed’s monetary policy outlook. The Fed is scheduled to announce its next rate decision on October 28, and officials are currently in a pre-meeting communications blackout period. Based on rate market pricing, traders estimate there is about a 20% chance the Fed will raise rates at this meeting.

Although this probability has not yet become the market's main expectation, developments in the Middle East and energy price changes could still influence investors’ views on the future path of interest rates.

Meanwhile, the US Treasury market is also feeling pressure from new bond issuance. Wednesday’s auction of 20-year Treasuries saw the winning yield reach the highest level for this maturity since the Treasury resumed issuance in May 2020, highlighting the current elevated cost of long-term financing.

Beyond inflation and supply factors, the performance of US equities is also influencing bond market moves. On Wednesday, US stocks rose, temporarily weakening demand for Treasuries as safe havens and pushing yields higher. However, after news regarding the Middle East situation emerged, the rally in US stocks was briefly disrupted.

Notably, the relationship between US stocks and the bond market has also shifted recently. Over the past two weeks, stocks of US-listed companies related to artificial intelligence (AI) infrastructure spending have slumped sharply, raising concerns about whether massive AI investments can continue to deliver sufficient profits. Meanwhile, some investors are beginning to worry that US economic growth could slow down, so even if international oil prices keep climbing, capital is still flowing into Treasuries in search of safety.

This pattern of capital flows demonstrates that the bond market is currently being pulled by multiple forces. On one hand, rising energy prices, inflationary pressures, and Fed rate hike expectations are putting pressure on bond prices; on the other, tech stock corrections and recession risks could boost demand for safe-haven assets.

Overall, the Middle East situation has once again become a critical variable affecting global financial markets. As international oil prices approach the upper bound of the volatility range seen since February, investors will closely monitor whether the conflict escalates further and whether rising energy prices will prompt the Fed to maintain a more hawkish monetary policy stance.

Before the Fed's rate decision on October 28, oil price trends, geopolitical news, and the market's repricing of the inflation outlook are expected to remain key factors influencing US Treasury yields and the performance of the dollar.