The Iran war is changing the bond playbook

This article was first published in Barron’s on 27 April 2026.

Wars are typically bad for bonds. They destroy critical infrastructure that must be rebuilt and drive commodity demand, creating inflationary pressures that erode fixed income.

So far, investors are dusting off the playbook they used after Russia’s invasion of Ukraine and are selling bonds, assuming central banks will respond to the Iran war's upward pressure on inflation with higher policy rates. Higher interest rates make bonds less attractive.

But these investors might be overestimating the odds that central banks will raise rates in response to the war. Hits to economic growth caused by commodity supply shocks may make central banks reluctant to hike rates, even amid elevated inflation. While bonds can still be an effective hedge in an economic slowdown, investors may be better off looking outside the world’s core bond markets right now.

In the US, a weakening macro picture makes rate hikes in response to inflation less likely than in 2022. The US experienced net job losses in the six months leading up to the Iran war. Its households no longer have a large savings buffer. More than US$2 trillion in pandemic-era excess savings has largely been spent. Savings rates are nearing historic lows.

Other developed economies, particularly commodity importers, are more vulnerable to war-related shocks than the US, which remains relatively insulated from oil price spikes because of its domestic shale production. Elsewhere, the growth strain will be more visible. Fuel-importing countries are already shortening workweeks, cutting output, and hoarding commodities.

Monetary policy is ill-suited for these kinds of shocks. Rate hikes can cool demand-driven inflation, but they do little in supply-side disruptions. Faced with higher input costs, companies are more likely to cut production and lay off workers. Meanwhile, households, which are already concerned about job security due to AI, might raise their precautionary savings rate, further slowing growth.

In an environment of weakening consumer activity, it is unlikely central bankers greatest fear — that inflation expectations will become unanchored — will come true.

This isn’t an all-clear signal for bond holders. Changes in the economics of warfare are creating higher fiscal demands. Russia’s early advances in Ukraine quickly stalled as low-cost drone technologies neutralized traditional military advantages. A similar dynamic is playing out in the Middle East. While US and Israeli forces established air superiority and destroyed much of Iran’s conventional navy, Iran has retained the ability to disrupt infrastructure and shipping through asymmetric tactics, particularly drone deployment. The cost of maintaining military superiority is rising as technological innovation accelerates, even as traditional military capital like tanks, ships, and aircraft become more vulnerable and depreciate faster.

That reality is already shaping fiscal policy. Congress is considering a US$1.5 trillion defense budget proposal. Europe is on a multiyear increased defense spending plan. China is likely to follow a similar path.

For bond markets, this introduces a structural tension: The world’s largest bond markets — the US, Europe, China, and Japan — may face sustained upward pressure on yields as governments finance higher defense spending through deficits, but, at the same time, the growth shock stemming from the Iran war points in the opposite direction, arguing for lower yields.

In this environment, smaller developed markets and emerging markets may offer more attractive opportunities for bond investors. Without global hegemonic ambitions, these countries are less likely to pursue costly military buildups. They can focus instead on relatively inexpensive defensive capabilities. As a result, their bond markets may respond more to global growth dynamics rather than to persistent, debt-funded fiscal expansion.

Ultimately, the key question is whether the dominant effect of the Iran conflict is higher inflation or weaker growth. Markets have so far leaned toward the former. If the latter proves more important, investors will need to broaden their approach — seeking resilience not in traditional safe havens, but in markets less exposed to the fiscal demands of great-power competition.