War, shock and…
15 OCT, 2026
By Jean-Philippe Donge from Banque de Luxembourg Investments
An uncompromising ECB, states facing unequal energy bills, and correlations shifting abruptly: the 2026 shock is reshuffling the deck on the bond markets. Now more than ever, it is vital to avoid ending up” on the same side of the shock”.
1. War, shock and monetary policy
The current conflict in the Middle East has changed the world economic landscape and, consequently, the bond markets. One the eve of the first US strikes on Tehran, the German 10-year benchmark bond yield was around 2.7%, whilst that of the US government bond with the same maturity stood at 4% per cent. Nearly seven months later, the former stands at around 3.5%, whilst the latter is approaching 5.3%.
The oil shock that followed these initial strikes explains this rise in yields and has led to renewed inflationary pressures. These pressures have fuelled the correction in the bond markets and have also called into question the monetary policy stance adopted in 2024. In February, headline inflation in Europe was below the 2% target, allowing the European Central Bank (ECB) to consider a further cut to its key interest rate. Since then, inflation has risen to around 3.8% and the ECB has raised its deposit rate by 50 basis points to 2.5%.
This is not the first oil shock in history, and past shocks have taught us that it is not only a matter of oil prices or politics; it is also a challenge for governments (which pay the bill), central banks (which may be forced to choose to let prices spiral) and the fixed-income markets. In 1973 (Yom Kippur War) and then in 1979 (Iranian Revolution), central banks had either been too accommodative, deciding to protect growth, or had been slow to act (Volcker, who was chairing the Federal Reserve, did not intervene until well after the sharp rise in inflation). In 2022, facing inflationary pressures driven by both the recovery from the health crisis and the energy shock linked to the war in Ukraine, they had, on the contrary, worked to fight them by raising interest rates drastically, thereby supporting the rebalancing of supply and demand. In 2026, the same central banks are once again being forced to act.
However, the current context is radically different. In the 1970s, the world faced an oil shortage, whilst central banks lacked both the courage and the experience to deal with it. In 2026, the world has more energy, holds strategic reserves, whilst the economy is less dependent on oil (as a proportion of GDP). The disruption to supply volumes in 2026 is more widespread than in 1973, but the rise in prices is not on the same scale. Even so, the Strait of Hormuz and the shock to gas supplies have disrupted the pre-war equilibrium of the global economy. Overall, what is hurting the bond markets is not the height of the peak oil price but rather entrenched inflation, which is forcing interest rates to remain higher for years.
Within the eurozone, the ECB remains uncompromising on its 2% inflation target. This intransigence is a fundamental factor for every bond fund manager: it means persistently higher interest rates, at the risk of weighing on growth, and therefore directly determines the duration to adopt.
It is clear that Europe is prioritising keeping inflation under control, whilst across the Atlantic, the Federal Reserve is still trying to achieve the best possible balance between growth and inflation. The latest decisions confirm this: the ECB has already raised its rate by 50 basis points, bringing it to 2.5%, whereas the Fed only very recently announced its first 25-basis-point hike, bringing the Fed Funds rate to 4%.
2. War, shock and solvency
Beyond interest rates, the shock also reshuffles the deck amongst borrowers. The shocks of 1973 and 1979 had enriched exporting countries and weakened importing countries. Even today, the oil shock triggers different dynamics depending on the nature of the affected economies, and three distinct profiles are emerging.
The first profile comprises countries that sell commodities whose prices have risen (oil, metals, and sometimes agricultural produce) and therefore see their revenues and currencies remain strong. We are thinking in particular of Kazakhstan, Uzbekistan and Mongolia.
The second profile includes countries that “buy the shock” having already high levels of debt. These countries are paying more not only for their energy but also for their refinancing. France is the perfect example: a net importer of oil and gas, with a strained budget and its creditworthiness being called into question on the bond markets… France is being hit hard by this crisis and is seeing its credit spread relative to Germany widen significantly. The third profile comprises countries in transition that are neither major exporters nor heavily indebted importers, and which, in such a context, may be able to identify potential opportunities.
3. War, shock and bond management
These two perspectives – monetary and sovereign – are directly reflected in our investment decisions. In absolute terms, we believe that fixed income management is based on the principles of quality, flexibility and cost management. At BLI, we focus on three performance drivers: duration management, exposure to specific credit risks, and the identification of opportunities in currencies other than the euro or the dollar.
Let’s start with duration, which, in times of shock, is the most sensitive factor as it is the one most directly influenced by central bank policy; positioning in this area will depend on the consequences of the shock: deflation or stagflation? Depending on the outcome, duration positioning can prove highly rewarding or utterly detrimental.
Credit, meanwhile, thrives on the redistribution of creditworthiness described above: taking on risk in an exporting country with a lower credit rating can be just as profitable as it is uncorrelated across a cycle.
Finally, on the currency side, the currency of a commodity-exporting country can represent a speculative bet or even a hedge for the country’s purchasing power.
In the current environment, where geopolitics interplays with the macroeconomic landscape, these three levers cannot be managed separately: their correlations shift, sometimes abruptly. Managing a bond portfolio in silos – by segregating bond asset classes without taking account of these shifting yet at times significant correlations – amounts to losing sight of the discernment necessary to optimise performance. Hence our conviction that unconstrained management is more essential than ever: based on the quality of issuers, it must be capable of wisely adjusting duration, spread and currency to achieve the portfolio best suited to the characteristics of the current crisis.
