By Robert Tipp, Head of Global Bonds at PGIM
Once again, geopolitics have come to the fore, creating a swirl of possibilities for the world’s economies and shockwaves for the markets. The drama playing out in the Middle East is pushing energy prices higher, exacerbating what is now a widespread problem of perniciously above-target inflation.
As a result of the macro backdrop, traders rushed to price in central bank rate hikes, pushing yield curves higher and flatter. Equities and credit products have nonetheless proved resilient with stocks hitting new highs while, similarly, credit spreads have almost recovered from March’s widening, taking them back toward historic lows.
Rates Selloff: Enough, or Not Until Oil Crests?
In the abstract, following the recent rise in rates, most economists and investors would probably see value in the bond market, with the hawkish rate paths now priced in appearing quite aggressive. Indeed, with markets now anticipating 75 basis points (bps) of hikes over the next year or so in both the UK and euro market, 100 bps of hikes in Japan, and nearly 50 bps of hikes in the U.S., it raises the question of whether yields overshot fair value on the high side.
But there is nothing abstract about the rising price of oil and supply chain shocks aggravated by the situation in the Middle East. As a result, while we’re inclined to think the majority of the bad news is priced in and rates are near the top of their new range, a stabilization of yields may have to wait for a topping of energy prices and a cresting of inflation risks.
Credit and the Crisis
It’s a bit surprising that after an initial widening in reaction to the outbreak of war, credit spreads have nearly fully recovered, and stocks have rallied to new highs. Are the markets Pollyannish and underestimating the risks, or is there a message in the strong trading behavior to date?
Looking at the bigger picture, periods of risk-off trading since COVID—spread widenings in response to the 2022 rate hikes and the Russia-Ukraine conflict, 2023’s Silicon Valley Bank collapse, 2025’s tariff developments—have been progressively mild, with each successive crisis having less of an adverse impact on the market than the last.
Our working assumption is that, in the wake of COVID, credit fundamentals are not only strong, but also fairly resilient to shocks. As investors catch on to this fact, each successive event experiences a shorter, shallower risk-off dip, followed by a speedier recovery, raising the possibility that credit markets may weather the unfolding Middle East crisis relatively unscathed.
Wait and See
If the Russia-Ukraine conflict is any indication of modern warfare, we could be in for an extended period of uncertainty surrounding the Middle East conflict as well as the economy and markets, leaving substantial upside and downside risks surrounding our outlook.
Yields in the Strategic Buy Zone
As we noted in late 2022, when yields first returned to their currently higher, but historically normal range – over the long run, yield is, more or less, destiny. On that point, the Middle East conflict has, in our view, pushed yields up to attractive levels. So, while it’s difficult to know when we’ve passed the peak of the current crisis in terms of yields and volatility, we are guardedly optimistic that most of the increase in rates is likely behind us. In that event, the market is well poised from current respectable yield levels to deliver solid returns in the years ahead.
