Sure, bonds are safe again

Perhaps the dollar is trying to tell us something. It has climbed to its highest level in two months even as oil has slipped back below USD100, hopes of diplomacy in the Iran war have improved and risk appetite has returned to global markets. Normally, cheaper oil and friendlier markets would take some shine off the ultimate safe haven. Yet the greenback keeps rising. Could it be that investors have finally decided to believe the Federal Reserve? Last week’s quarter-point hike, the Fed’s first in three years, certainly changed the conversation. Markets now attach roughly even odds to another increase in October, have a further quarter-point move fully priced by December and expect more tightening beyond that. Fed officials have reinforced the message that stubborn inflation may require additional action. Rate differentials have consequently shifted further in the dollar’s favour, pushing the euro and sterling to their weakest levels since late July. So far, so straightforward. Except the same repricing that is lifting the dollar is beginning to produce a rather more intriguing proposition elsewhere: after six miserable years, bonds are starting to look tempting again. And miserable hardly overstates it. Long-term G7 government bond prices have almost halved since the pandemic lockdowns of 2020, while Treasury investors are enduring another bruising year. Yields on 10- to 30-year government debt across major economies have reached levels not seen in decades. Yet every fresh yield high also improves the prospective return for somebody prepared to buy. With 10-year Treasuries around 5 percent, and the S&P 500 earnings yield only slightly higher, government debt suddenly offers competition for money that spent years being forced into riskier assets. Could the great bond bear market finally be exhausting itself? Some serious investors are beginning to wonder. Fund managers remain unusually underweight bonds, leaving plenty of room for repositioning if sentiment turns. RBC BlueBay, the specialist fixed-income arm of RBC Global Asset Management, now believes the worst of the 2026 bond rout may be behind us and has become more constructive on duration. Goldman Sachs expects some of the aggressive monetary-policy repricing to unwind eventually as underlying inflation softens. After a decade when investors had to hunt increasingly exotic corners of markets for yield, high-quality fixed income is once again offering quite a lot of it without requiring much imagination. Which is usually about the point when markets become dangerous. The argument for bonds depends heavily on what happens next to inflation. The Fed has begun tightening, more tightening is priced in, speculative positions have been flushed out and sufficiently high rates should eventually restrain demand. If inflation expectations settle, today’s yields could look very attractive indeed. But how much of that argument quietly assumes that the energy shock is also settling? Brent has fallen back towards USD99 as hopes rise that diplomacy surrounding the seven-month Iran war might finally produce something useful. Yet crude remains roughly 37 percent above where it stood when the conflict began. Diesel prices remain exceptionally high, the Strait of Hormuz is still central to the supply outlook, and the extraordinary distortion in refined-product markets has hardly disappeared simply because Brent has surrendered a few dollars. Markets, in other words, may be pricing monetary tightening with considerably more confidence than they can price the war that helped make the tightening necessary. What happens if diplomacy works and Hormuz gradually normalises? Oil could ease further, inflation pressure would diminish, central banks would have less reason to keep tightening and the case for extending bond duration would strengthen considerably. The dollar’s current rate advantage might eventually peak as well. That is a perfectly coherent trade. But what if the war escalates again? That question matters more now because the cushion against another serious oil disruption is thinner than it was earlier in the conflict. Another sharp energy spike would feed back into inflation expectations just as central banks are trying to convince markets that price pressures are coming under control. Would three more Fed hikes still be enough? Would 5 percent Treasuries still look irresistible if oil were racing higher again? And would investors buying duration today discover, as others repeatedly have during this bond bear market, that apparently extraordinary yields can always become slightly more extraordinary? Kevin Warsh adds another complication. The new Fed chair dislikes forward guidance, has declined to provide his own dot-plot forecast and has questioned the operational usefulness of familiar anchors such as the neutral rate. His preference appears to be for judging the direction and persistence of inflation rather than allowing models or individual data points to dictate policy mechanically. Markets contemplating a large duration bet must therefore forecast inflation while simultaneously learning how a new Fed regime intends to respond to it. What could possibly go wrong? For Pakistan and similar frontier economies, this argument is hardly an academic contest between bond managers. A stronger dollar raises pressure across countries dependent on imported energy and external financing. High Treasury yields make US government debt more competitive against riskier emerging-market assets. And another oil surge would threaten the import bill, the currency and domestic inflation at precisely the moment when expensive global capital already limits room for manoeuvre. The uncomfortable combination is therefore easy enough to imagine: a stronger dollar, stubbornly high US yields and another energy shock arriving together. Pakistan would have little influence over any of them and considerable exposure to all three. Perhaps the bond bulls are right. Perhaps USD99 oil becomes USD90, diplomacy holds, inflation retreats and today’s yields turn out to have been the opportunity everyone had been waiting for after six punishing years. But with a war still raging, Hormuz still uncertain and a new Fed deliberately making itself harder to predict, could markets once again be celebrating dawn while it is still dark outside? Copyright Business Recorder, 2026

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