The Iran war hasn’t merely driven up the prices of oil, diesel fuel and gasoline. It also bears major responsibility for the painful increase in interest rates the world has been experiencing since the end of February.
Much attention in the United States has been focused on the Federal Reserve, which on Wednesday raised the key short-term interest rate it controls by a quarter of a percentage point to a range of 3.75 to 4 percent. But when you look at what’s happened to interest rates this year, it’s evident that the Fed is trying to catch up to a surge in bond rates that has been underway for months. The Fed has just signaled that it is likely to raise rates by another quarter-point this year. But the bond market is saying that if current conditions persist, it expects the Fed’s short-term interest rates to go much higher.
Collectively, the thousands of bond traders who set longer-term rates have acted with blinding speed this year. The Iran war began on Saturday, Feb. 28. When the bond market reopened two days later, traders began pushing longer-term rates higher.
In hindsight, that weekend marked the start of an unmistakable trend in the global economy and in financial markets.
Energy prices, which had adjusted to the supply shock of the war in Ukraine, began to levitate again. The pace of inflation, which had been ebbing, began to accelerate — and global interest rates began moving upward as perceptions of global risk spiraled.
The yield on the benchmark 10-year Treasury note on Thursday hovered close to 5 percent. For 30-year Treasuries, the yield was almost 5.3 percent. And for two-year Treasury bills — a measure that suggests where the market believes the Fed’s short-term rate will stand in two years — the yield approached 4.7 percent.
How high interest rates, oil prices and the rate of inflation will go — and how long they will remain at elevated levels — are critical issues, with midterm elections less than two months away in the United States and markets in turmoil across the globe. Mortgage rates have risen close to the 7 percent level for the first time this year, after dropping just below 6 percent in the week before the war. Costs have been rising on credit card debt and student loans, and on big capital projects, like artificial intelligence data centers built on mountains of borrowed money.
Rising rates and soaring energy prices are causing hardship for millions of people, and not just in the United States. There have been protests against fuel shortages and irksome prices in countries from Indonesia to Guatemala to Syria, as my colleague Damien Cave reported this past week. Central banks in Tokyo, London and Brussels have responded with the tools at their command, raising shorter-term rates or indicating that they are likely to do so. Bond market rates in many global financial centers teeter at peak levels last seen decades ago.
Still, the global economy has continued to expand and there are few signs of immediate recession. While major stock markets have stalled this month, many remain near recent highs. One way of explaining this is to note that in the decades before the global financial crisis of 2007, interest rates were in the vicinity of where they are now — and markets and economies in general were able to cope with them. Whether the current uncomfortable situation in the markets becomes significantly more painful, as it did in 2007, may depend on whether the upsurge in energy and bond rates continues.
Whatever the central banks do, their power to control inflation is constrained because the causes of the immediate problems are elsewhere. Many of them emanated from Washington, with President Trump’s repeated imposition of steep tariffs; the U.S. government’s enormous deficits causing a glut in the supply of bonds; and the fateful decision to go to war.
Tariffs and War
The markets were relatively calm in the week before the war. On Feb. 20, the Supreme Court struck down President Trump’s tariffs, ruling that he had exceeded his authority by invoking the International Emergency Economic Powers Act of 1977 to set taxes on imported goods from more than 100 countries.
The effective tariff rate, which peaked at 11 percent in late 2025 and was an important cause of rising consumer prices, fell to 7 percent, according to an account from the Federal Reserve Bank of St. Louis. With that factor ebbing, and with apparent reason to expect that inflation would trend downward, the bond market reacted by lowering interest rates.
On Friday, Feb. 27, the day before the war started, the yield on the benchmark 10-year Treasury dipped below 4 percent for the first time since November. According to FactSet, it closed that day at 3.96 percent, its bottom so far this year.
But that move was short-lived. On Saturday, the United States and Israel attacked Iran. On Monday, the 10-year yield rose back above 4 percent. It hasn’t dropped below that level since.
Bond yields around the world have largely tracked energy prices this year, particularly the price of a barrel of Brent crude, the benchmark for global oil prices. It was still below $60 a barrel as late as Jan. 22, according to FactSet. But in mid-January and in February, it began rising “in response to increasing risk of a conflict in the Middle East,” according to the U.S. Energy Information Administration. It began to skyrocket after the start of hostilities, and by mid-April, exceeded $100 a barrel. With periodic declarations of cease-fires, the price declined, but the war, which President Trump originally said would last “four to five weeks,” never entirely stopped.
The conflict has broadened lately, and disruptions of Middle East oil supplies have worsened — once again propelling the price of oil above $100 a barrel, and contributing to renewed worries about inflation. In the United States, the inflation rate remains uncomfortably high.
On top of the toll of the war, the new Trump tariffs have pushed the U.S. effective tariff rate back up to 11 percent, according to the Yale Budget Model. Inflation has become an inescapable political and economic issue.
In a note to clients earlier this month, Mark Zandi, the chief economist at Moody’s Analytics, described the surge in yields this way: “Just over half of the run-up traces directly to the war, which flipped expectations from Fed rate cuts to rate hikes.”
Most of the rest of the increase, he added, comes from what economists call “the term premium” on rates. He defined that as “the extra yield investors demand for bearing long-term risk — driven by a mélange of factors, most significantly murkier Fed communication and massive federal government borrowing.”
Other factors have pushed rates higher, too. With interest rates rising in Japan, the U.S. bond market looks less appealing on a comparative basis, perhaps reducing demand for Treasuries. Sovereign governments have cut down on their Treasury stakes, while hedge funds, which tend to move rapidly in and out of markets, are playing a more important role than in years past. Treasury Secretary Scott Bessent, a former hedge fund trader, has tried to stem the tide and lower U.S. yields through Treasury interventions, with little effect.
Because higher bond yields mean falling prices for bonds, many investors in bond mutual funds have taken some losses this year. But now that higher yields are in place, they are likely to produce richer income streams in the years ahead, so bond fund holders are likely to benefit ultimately from the recent turmoil.
As for the stock market, who knows how long the current A.I.-fueled bull market will last? Trying to time the markets doesn’t make sense to me as an investor because I can’t predict the future. Sticking with it, using low-cost, diversified funds, in an appropriate mix of stocks and bonds for you, is a better way to go.
But be aware that much depends on government policies, and on a Middle East war that, on the face of it, was much easier to start than to end.
The post What Set Off the Rise in Interest Rates? Mainly, the Iran War. appeared first on New York Times.
