Geopolitics upset a vulnerable equilibrium<p></p> Geopolitics upset a vulnerable equilibrium<p></p> http://www.federatedinvestors.com/mmdt/static/images/mmdt/mmdt-logo-amp.png http://www.federatedinvestors.com/mmdt/daf\images\insights\article\man-sunset-beach-small.jpg April 10 2026 April 10 2026

Geopolitics upset a vulnerable equilibrium

Bond markets gave up gains during Q1 as inflation concerns outweighed risk-off instincts.
Published April 10 2026

Two months into the first quarter, fixed income investors were enjoying a solid start to the year with the Bloomberg US Aggregate and Global Index returning 1.75% and 2.06% respectively. Markets appeared to be benignly balanced at the end of trading on February 27. March was, of course, a different story as the attack on Iran took center stage. Investor consensus initially centered around the conflict being  short lived, but potential ripple effects of spiking oil prices soon became the dominant theme and increasingly the greater concern to markets.

An abundance of uncertainty

Acts of war can often result in a “risk-off” flight to safety that potentially benefits bond investors. This time, the surging oil price revived inflation concerns and the combination of uncertainties pressured returns across asset classes. By the end of March, the US 10-year yield bounced from 3.94% to 4.33%, well off its trailing 12-month high, but enough to help erase year-to-date total return gains. By contrast, equities fell more precipitously through March, with the S&P 500 underperforming the Bloomberg Agg by 430 basis points (bps) for the first quarter.

In a typical risk-off environment, rates move down first and spreads widen significantly. This environment was a bit more of an “inflation-on” dynamic, with the US Treasury yield curve flattening as shorter-end yields rose much more than the long, amid expectations switching from an eventual Fed ease to maybe even a hike in 2026. Spreads rose only slightly compared to what we would expect in a true risk-off scenario. By comparison, US high-yield spreads were at 460bps as a result of the April 2025 tariffs announcement vs. 346bps at the end of March this year.

Making adjustments

During the first quarter, Federated Hermes fixed income committees met with extra frequency to assess positions. Our Duration committee made small adjustments from long, to short, to neutral and back to long as benchmark yields reached key levels and events in the conflict suggested a potential for delay or de-escalation. We also moved from a steepener to neutral on the Yield Curve committee as the flattening pattern emerged and Fed expectations swung from eases to, at times, hikes. Within sector recommendations, we upgraded our view on US investment grade to neutral while remaining underweight in the higher spread volatility sectors of US high yield and US dollar-denominated emerging markets. Relative strength of the US dollar combined with pressure on oil prices drove a shift lower in our local currency exposures in global markets.

Overall, opportunities for alpha were limited during the first quarter due largely to competing uncertainties. But what begins as modest volatility can evolve into a more defined trend. Can the coming days and months provide resolution to problematic geopolitical and macro factors? Open questions include:

  • Is there a workable plan to end the Iran conflict now that there is a ceasefire to be followed by direct negotiations?
  • Can oil prices retreat or will they stay elevated, creating a drag on growth?
  • Are private credit issues a bump in the road or something more significant?
  • If the US economy becomes stagflationary, what will be the extent?

The first two questions are interdependent and oil prices did fall upon the ceasefire announcement. Private credit could be a catalyst for further spread widening. Its market size is comparable to that of subprime 20 years ago, which means as a percentage of the economy it is much smaller and, by definition, not concentrated in the banking system. That said, its contagion risks remain open to speculation as investors who cannot sell private credit may choose to reduce risk in other credit holdings. A recent rebound in employment is a positive, but threats to growth coupled with inflationary downstream effects of oil prices are likely major themes in Q2.

We believe that bond market equilibrium will continue to be vulnerable as current political and macroeconomic factors have the potential to tip to sharply slow the US economy. In the meantime, being underweight in volatile spread sectors with rich valuations seems reasonable as spread widening, with or without a recession, seems likely.

Read more about our current views and positioning at Fixed Income Perspectives  

Tags Fixed Income . Geopolitics . Interest Rates . Monetary Policy .
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Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices.  In addition, fixed income investors should be aware of other risks such as credit risk, inflation risk, call risk and liquidity risk.

Alpha measures the excess returns of a portfolio relative to the return of a benchmark index.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

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