All asset classes were severely impacted last month following the conflict in Iran that erupted in late February. Within days, the Strait of Hormuz – the narrow maritime chokepoint through which roughly one-fifth of the world’s oil supply transits daily – had been effectively closed to commercial shipping.
Although sovereign bonds are normally perceived as a ‘safe haven’ in times of conflict, with an assumed upward movement in prices, the immediate reaction in the bond market since the start of the conflict on February 28 has been precisely the opposite.
Why sovereign bond prices are falling
The war in Iran resulted in an energy supply shock to the global economy. Brent crude, which was trading around $73 a barrel on the eve of the conflict, surged to above $110 a barrel – a gain of over 55% within a month. Natural gas prices also jumped in a similar manner.
The impact on inflationary expectations was immediate as higher energy costs feed directly into consumer prices, threatening to push inflation well above the 2% targets maintained by most of the major central banks.
The bond market’s strong reaction encapsulates the fear of a return to the stagflationary dynamics last experienced in 2022, or, in a more adverse scenario, an echo of the energy crisis of the 1970s. In view of the risk of higher inflation, investors are demanding compensation through higher bond yields.
The surge in yields
Given the inverse reaction between yields and prices, the sharp upturn in yields translates into lower bond prices. This was evident across all sovereign bond markets worldwide.
In the US, the benchmark 10-year Treasury yield rose from approximately 4.0% before the conflict to 4.45% – an increase of 45 basis points (bps) within the space of a month. The two-year Treasury note, closely tied to Federal Reserve policy expectations, climbed from below 3.5% to above 4.0%.
Most market commentators now do not expect any interest rate cuts by the Federal Reserve in 2026 – a significant contrast from the expectations of one or two rate cuts before the hostilities began.
In Europe, the movements in some sovereign bond markets have also been significant. Germany’s 10-year Bund yield – the risk-free benchmark for the euro area – surged from approximately 2.65% to around 3.1%. This naturally impacted other bond markets across Europe, including Malta.
Italy’s 10-year borrowing costs climbed above 4.1% (their highest since mid-2024), representing a rise of almost 80 basis points last month, a move comparable in scale to the region’s last energy crisis of 2022. France’s 10-year yields touched a high of nearly 3.9% – their highest level since 2009, – while Spain’s 10-year yield rose to over 3.6% for the first time since late 2023.
Since the daily indicative Malta Government Stock (MGS) prices quoted by the Central Bank of Malta are based on the movements across the eurozone, the surge in yields was also evident in Malta. The yield of a 10-year MGS jumped from 3.53% on February 27 to over 4.05% towards the end of March.
In terms of price movements, this is reflected in the indicative bid price of the 2.5% MGS 2036, which slumped to 86.58% from 90.87% at the end of February.
“The higher yield that should be available for investors in the coming weeks is possibly one of the few positive highlights from the ongoing conflict in the Middle East”
The movement in sovereign spreads
The additional interest premium that investors demand to hold the bonds of so-called peripheral eurozone economies over German bunds – has also been noteworthy. Italy’s spread over Germany was approximately 60 basis points before the conflict erupted. It has since widened back to almost 100 basis points.
A number of market commentators do not believe there are significant concerns over eurozone sovereign risk for now. However, this is dependent on the duration of the conflict, and whether the fiscal measures being introduced by countries to stem the effect of the energy crisis on consumers will become more expensive.
Spain has already approved a tax relief package worth €5 billion, reducing VAT on electricity, natural gas, and fuels from 21% to 10%. Italy has cut fuel excise taxes by 20% in an interim measure costing some €417 million until early April until a further review is considered.
The ECB reaction
As expected, during the European Central Bank’s Governing Council meeting on March 19, the deposit facility rate was left unchanged at 2%. However, the language and projections accompanying the decision were much more cautionary than at any point since the post-pandemic tightening cycle.
The ECB’s updated staff projections, which exceptionally incorporated data up to March 11 given the extraordinary circumstances, now envisage headline inflation averaging 2.6% in 2026, 2.0% in 2027, and 2.1% in 2028. This represents a meaningful upward revision from the December projections, which had envisaged inflation remaining just below the 2% target in the next few years.
In adverse and severe scenarios with oil prices remaining above $100 a barrel for a sustained period, the ECB warned that euro area inflation could peak as high as 4% this year, and potentially above 6% in early 2027 if energy infrastructure damage proves more severe and persistent. Economic growth, meanwhile, has been revised sharply lower to just 0.9% in 2026.
ECB president Christine Lagarde’s remarks following the March 19 meeting represented a notable shift from her previous statement that the euro area is in a “good place”. She said the Governing Council was “well-positioned and well-equipped to deal with the development of a major shock that is unfolding”, while warning that the war “has made the outlook significantly more uncertain”, creating “upside risks for inflation and downside risks for economic growth”.
In another speech a few days later, the ECB president hardened her tone further, saying that even if the inflation overshoot from the energy shock proved “not too persistent”, policymakers stood ready to tighten monetary policy – effectively putting rate hikes back on the table for the first time in over a year.
Market participants are now anticipating that the ECB will raise its benchmark interest rate three times this year. The ECB’s next Governing Council meeting is scheduled for April 30.
Implications for Maltese investors
For many retail and institutional investors in Malta, who have long favoured MGSs as a core component of their investment portfolio, the surge in yields in the past few weeks represents a potentially more attractive entry-point into the Malta sovereign bond market in the upcoming new MGS issues being offered to the public later this month.
Following a surprising delay by the Treasury to publish its indicative issuance calendar for this year, and the lack of issuance in Q1 in view of the requirement for record issuance in excess of €1.9 billion in 2026, it has now been confirmed that a 10-year and 15-year issuance will take place this month. It is interesting to note that when a 10-year MGS was issued at a yield of 4% in October 2022, there was a record of subscriptions by retail investors amounting to just under €300 million.
This is proving to be yet another very uncertain period for all asset classes. The higher yield that should be available for investors in the coming weeks is possibly one of the few positive highlights from the ongoing conflict in the Middle East.
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