The first quarter of 2026 saw a dramatic shift in global bond markets, as geopolitical tensions and renewed inflation pressures forced investors to abandon earlier expectations of monetary easing. Data from Eurex reveals that March became a pivotal turning point, with energy market disruptions triggering a broad repricing across fixed income markets.
Energy Shock Reverses Disinflation Expectations
The link between geopolitics and inflation became the central theme of the quarter. Escalating conflict in the Middle East translated into a supply shock that pushed energy prices higher, reintroducing inflation as the primary concern for markets. This reversal ended the disinflation trend that had begun to take hold at the end of 2025 and set off a broad sell-off in government bonds.
Inflation expectations moved higher across major economies, prompting investors to question how quickly central banks could cut rates. Yields rose across the curve in both the United States and Europe, with longer-dated yields moving more sharply as repricing reflected sustained price pressures tied to commodity markets.
Central Banks Hold Rates Amid Shifting Expectations
During the quarter, both the Federal Reserve and the European Central Bank held policy rates unchanged, with the Fed at 3.75 percent and the ECB at 2.15 percent. The ECB maintained that underlying inflation trends had not fully reversed despite volatility. Markets, however, moved ahead of central banks: earlier expectations for rate cuts in the United States were scaled back, while pricing in Europe began to reflect the possibility of further tightening.
The gap between policy signals and market pricing highlighted how regional dynamics influence rate expectations differently, even when both economies face similar external shocks. Investors adjusted positions based on forward-looking risks, while central banks moved more gradually.
Yields Rise and Curves Steepen
The bond sell-off drove yields higher across the curve, with German Bunds and U.S. Treasuries reflecting the shift in inflation expectations. The spread between two-year and ten-year yields reached 53 basis points in the United States and 40 basis points in Germany, indicating that long-term inflation expectations played a larger role than short-term policy expectations.
Euro area peripheral debt showed resilience, with the spread between Italian 10-year bonds and German Bunds narrowing to 90 basis points, suggesting continued demand for higher-yielding assets despite overall rate increases.
Trading Activity Expands Amid Volatility
Derivatives markets experienced an 18 percent year-on-year rise in volumes across long-term interest rate futures, with open interest growing 20 percent in German markets, 31 percent in Italian markets, and 27 percent in French contracts. Average trade sizes remained stable across key contracts such as Euro-Bund, Euro-Bobl, and Euro-Schatz futures.
Liquidity conditions shifted during the quarter. Market depth reached high levels during stable periods, with top-of-book sizes in Bund futures exceeding 1,000 lots. However, during contract roll periods and heightened geopolitical tension, liquidity tightened to around 190 lots. Despite these fluctuations, execution remained stable.
Outlook Driven by Inflation and Geopolitical Risk
The outlook for bond markets depends largely on geopolitical developments and energy price stabilization. Inflation has reasserted itself as the main driver of policy expectations, and any further shocks could lead to additional volatility. Central banks are expected to maintain a cautious stance, balancing inflation risks against broader economic conditions.
In a parallel analysis, BNY highlighted that ECB inflation signals allow for a patient approach to monetary policy. Core inflation in the Eurozone fell to 2.4% in March 2025, while services inflation remained sticky at 4.0%. BNY's report emphasized that the ECB does not need to rush into further rate cuts, as the current deposit rate of 3.75% and elevated wage growth of 4.5% year-on-year support a cautious stance. Markets now expect two more cuts by year-end, but BNY argues this timeline may be too aggressive.
The experience of Q1 2026 demonstrates how rapidly expectations can change, with a market that began the year anticipating rate cuts moving within weeks to question whether easing would be delayed or reversed. This pattern is likely to continue if geopolitical risks remain unresolved.
