Bond investors have moved into a more defensive posture after the conflict in the Middle East injected fresh uncertainty into global markets. Many investors are increasing their holdings of short-term U.S. Treasuries as they wait for the Federal Reserve’s upcoming monetary policy decision.
The Federal Open Market Committee (FOMC) is widely expected to keep its benchmark overnight interest rate unchanged within the 3.50%–3.75% range when its two-day meeting concludes on Wednesday. Policymakers are closely evaluating how the ongoing Iran conflict could affect their dual mandate of maintaining price stability while supporting maximum employment.
Despite the cautious sentiment, many market participants still believe the conflict will remain relatively contained and short-lived. If that scenario plays out, the inflationary pressure caused by rising oil prices may remain limited. Stable inflation could eventually allow the Federal Reserve to lower interest rates later this year, potentially triggering a rally in U.S. Treasuries and the broader bond market.
For the moment, however, the combination of geopolitical risks, persistent inflation and signs of a slowing labor market has complicated investors’ outlook for Federal Reserve policy. Portfolio managers say this uncertainty has led many investors to avoid longer-term bonds until there is greater clarity on both the geopolitical situation and the central bank’s response.
Danny Zaid, portfolio manager at TwentyFour Asset Management, said investors are positioning themselves more cautiously and steering away from riskier segments of the bond market.
According to Zaid, interest-rate volatility is expected to remain elevated. As a result, many investors are maintaining a neutral duration strategy until there is clearer visibility on how the conflict develops.
Duration is a key measure of bond sensitivity to interest-rate movements. It estimates how much a bond’s price could rise or fall when rates change. A neutral duration strategy means keeping a portfolio’s maturity profile aligned with its benchmark. For example, if the benchmark duration is five years, the portfolio will hold bonds with roughly five-year maturities. Currently, this approach reflects a cautious stance that limits exposure to longer-dated bonds.
Recent data also highlights this defensive positioning. J.P. Morgan’s latest Treasury Client Survey shows that active clients now hold the largest outright short positions in U.S. Treasuries since early February, signaling an effort to reduce interest-rate risk.
In March, yields on two-year U.S. Treasuries climbed 31 basis points, putting them on track for their largest monthly increase since October 2024. The rise reflects growing concerns that central banks may struggle to cut interest rates if higher oil prices push inflation upward. The two-year Treasury yield was last seen around 3.69%.
However, some investors believe short-term yields may eventually decline. They argue that two-year Treasuries have already absorbed much of the selling pressure triggered by the conflict, pushing yields to their highest level in about seven months.
Energy markets have also reacted sharply to the geopolitical tensions. U.S. crude oil futures have surged 46% this month, marking the strongest monthly gain since May 2020.
Some analysts warn that rising energy prices could eventually weaken consumer demand. Brad Conger, chief investment officer at Hirtle Callaghan, noted that there is often a tipping point where higher energy-driven inflation begins to reduce consumer spending.
Conger added that U.S. Treasuries often act as a hedge during economic slowdowns, whether the conflict ends quickly or becomes prolonged.
Expectations for Federal Reserve rate cuts have also shifted. U.S. interest-rate futures markets have largely stopped signaling a significant rate reduction this year. Current market pricing suggests only about 24 basis points of easing, compared with 55 basis points expected before the conflict began, according to LSEG estimates.
Still, some investors believe the current rate environment could create opportunities, particularly at the shorter end of the yield curve. Seth Meyer, global head of client portfolio management at Janus Henderson Investors, said the front end of the curve may offer attractive opportunities as expectations for near-term rate cuts fade.
The debate over the future path of interest rates is likely to intensify when the Federal Reserve releases its updated economic projections on Wednesday. These projections include the closely watched interest-rate forecasts known as the “dot plot.”
During the Fed’s December meeting, when policymakers last reduced rates to the current 3.50%–3.75% range, the dot plot suggested only one additional 25-basis-point rate cut this year. The median estimate for the neutral interest rate — the level that neither stimulates nor slows economic growth — remained at 3%.
Overall, investors expect little change in the Fed’s forward guidance at the upcoming meeting, given the heightened geopolitical uncertainty.
Olumide Owolabi, head of the U.S. rates team at Neuberger Berman, said the next move in monetary policy remains difficult to predict. According to Owolabi, the Federal Reserve is unlikely to alter its long-term outlook significantly while uncertainty surrounding the conflict remains extremely high.
