Geopolitical shock drives oil prices and Treasury yields higher

Before the commencement and rapid escalation of hostilities in the Persian Gulf, economic data releases for early 2026 portrayed an accelerating US economy after its modest Q4 expansion pace of just 1.4%. Expected increases in tax refunds, rising construction spending linked to the continued AI infrastructure build, and the positive lagged effect of the 75 basis points (bps) of late-2025 Federal Reserve (Fed) eases all appear to support this constructive growth outlook. Yet US Treasury yields fell during February amid declining government bond yields in capital-exporting Japan, jittery risk asset markets linked to expected AI-disruption of incumbent firms, and fears of broader credit erosion in the opaque private credit market.

Then the US/Israel attack began on Iran, adding to market uncertainty. Crude oil futures have climbed almost 19% and the 10-year US Treasury yield has increased 20bps since the beginning of hostilities. Those two market variables are linked, as rising fossil fuel prices stoke concerns of renewed inflationary pressures and depress expectations for near-term Federal Reserve easing of monetary policy. In addition, rising Treasury yields reflect the open-ended nature of the conflict with Iran, raising the prospect of an expensive military campaign when the US fiscal deficit is already large. Sovereign bond yields have risen this month across all developed countries, excluding Japan, as global inflation concerns linked to oil prices overwhelmed the effect of any flight-to-quality buying.

Though oil prices  have surged, the increase has at least initially  been contained by abundant global production and supplies in place before the beginning of hostilities. The “spray” of missiles and drones around the Persian Gulf region by Iran has damaged some oil infrastructure and the shipping of oil through the Strait of Hormuz has nearly halted. The longer such disruptions persist, the more problematic the increase in spot oil prices becomes. Oil futures contract prices for delivery in September and afterwards are in the high $60s, below the current spot price of $80, suggesting markets believe the conflict will be contained and not last too long. Similarly, the market reaction in US stocks and corporate bond spreads has been modest. A report from the Pentagon Wednesday indicated the number of missile and drone launches by Iran have fallen sharply since the first day of the conflict—suggesting damaged launch capacity and/or diminished supplies—reinforces that view.

Amid the elevated uncertainty linked to the conflict in Iran, the higher Treasury yields that followed the start of hostilities, and the independent concerns around the deterioration of private credit market conditions, the near-term risk to US Treasury market yields appears symmetric. Thus, the Federated Hermes Duration committee has shifted to neutral from its prior small short position relative to index. As always, and particularly in view of current market tensions, we remain focused on the unfolding economic situation and are prepared to alter duration recommendations as warranted.