Global government bond markets have been hit by a severe sell-off, driven by a combination of renewed US-Iran military tensions, a sharp spike in oil prices, and Federal Reserve meeting minutes highlighting AI investment as a new inflation threat.

US Treasury yields have risen across the board, with the two-year yield nearing its highest level for the year and the ten-year yield briefly surpassing the 4.6% mark. European bond markets have seen even deeper declines, with UK and German long-term rates jumping significantly. Markets are now aggressively pricing in further interest rate hikes from both the Federal Reserve and the European Central Bank before the year's end.

Ceasefire Ends, Oil Spike Fuels Inflation Fears

The immediate trigger for the bond market turmoil was a sudden escalation in Middle East tensions. US President Donald Trump stated on Wednesday that the ceasefire with Iran was over. He made further military threats, saying the US would deal a heavy blow to Iran. This followed a series of Iranian attacks on vessels near the Strait of Hormuz, to which the US responded with airstrikes on Iranian targets and an attempt to block its legal oil exports, prompting Iranian countermeasures. The fragile temporary peace framework is on the verge of collapse.

In response, international oil prices surged. Global benchmark Brent crude futures broke above $79, while WTI crude futures traded at $74.30 per barrel. Although prices remain well below the peak of around $120 seen during the initial US-Iran conflict in late March, the fragility of the ceasefire has reignited strong market concerns about energy costs pushing inflation higher.

US Yields Surge, Rate Path Repriced

Anxiety from the commodities market quickly spread to fixed income. The policy-sensitive two-year US Treasury yield rose to 4.21%, having touched 4.235% intraday on Wednesday, just a step away from its 2025 high of 4.25% set on June 22. The benchmark ten-year yield, crucial for mortgages, auto loans, and corporate debt, climbed to around 4.58%, having briefly risen above 4.60% in early Wednesday trading, its highest level since May 21. The thirty-year yield also rose to 5.077%.

As yields jumped, pricing in interest rate futures markets shifted rapidly. Traders have repriced expectations, now betting the Fed will end its pause and start raising rates by October this year, whereas previous expectations had been pushed back to December. According to the CME FedWatch Tool, the probability of a rate hike at the September meeting has surged to over 80%, with an 83% chance of at least one hike by year-end, and a 44% probability of multiple hikes.

The release of the Fed's June meeting minutes on Wednesday afternoon further solidified market expectations for a hawkish stance. The minutes revealed a committee divided on the rate path but highly alert to inflation risks. They stated that "most participants judged that economic activity growth exceeding potential output, partly stemming from strong AI business investment, could lead to more persistent inflationary pressures." In discussing scenarios for persistently high inflation, "almost all of those participants indicated some degree of policy tightening would likely be necessary to return inflation to 2%."

AI Emerges as New Inflation Concern, Heavy Issuance Adds Supply Pressure

The most surprising detail in the minutes was the Fed's emphasis on AI-driven inflation. While "AI" was mentioned only 8 times in the April minutes, with just one reference linked to inflation, it appeared 20 times in the June minutes, with 7 instances directly associated with upside inflation risks. The minutes warned that while AI might lower inflation by reducing production costs in the long term, "such effects may take some time to materialize." In the short term, the frenzy of investment in AI infrastructure is now listed alongside tariffs and oil prices as one of the Fed's top three inflation threats.

Concurrently, corporate fundraising for AI is directly impacting bond market supply. Amazon.com Inc (NASDAQ: AMZN) launched a massive bond offering of at least $25 billion on Wednesday to support AI infrastructure, including long-term notes maturing in 2036. Analysts note this wave of corporate borrowing competes directly with government debt, pushing yields higher on the supply side. A $39 billion ten-year Treasury auction by the US Treasury on Wednesday saw a yield around 4.59%, the highest for a similar auction since February 2025, although a three-year auction on Tuesday still saw strong demand.

Selling More Intense Across the Atlantic

European bond markets experienced an even sharper sell-off. As European markets closed on Tuesday before the US-Iran developments, a severe "catch-down" occurred upon Wednesday's open. The German ten-year yield surged by 8 basis points to 3.068%, while the UK ten-year yield jumped by 13 basis points to a high of 4.957%.

The oil-driven inflation shadow is also pressuring European policymakers. Money markets in the eurozone now fully price in a 25-basis-point rate hike from the European Central Bank by October. Analysts stress that rising oil prices mean "the ECB cannot afford to let its guard down just yet." UK markets fully price in a 25-basis-point hike from the Bank of England by November, with about a 40% chance of a second hike before year-end.

Recent events underscore that the memorandum of understanding signed by the US and Iran in late June was merely "an agreement to agree to negotiate," not a substantive ceasefire agreement. With the fragile peace framework potentially unraveling and the structural inflation specter of AI capital expenditure, the calm in global bond markets has been shattered. Bond investors are now on high alert, fearing that the ceasefire collapse will trigger higher energy prices and inflation, and that the Fed's minutes have added fuel to the fire. Both major concerns have now materialized simultaneously.