Derivatives volumes smash records on Iran war inflation fears
Investors scrambling to protect themselves against rising bond yields sent interest rate derivatives volumes surging to all-time highs last week, as the prospect of a protracted conflict in the Middle East reignited fears over inflation.
A record US$20.1trn of interest rate derivatives notional changed hands last week, according to DTCC data collated by ISDA, roughly twice 2025’s average weekly volumes. That was spread across an unprecedented 113,264 derivatives trades, making it the busiest week for these markets on record by some distance.
The deluge of trading activity came amid a sudden spike in short-dated bond yields as investors bet central banks will have to change tack following a surge in energy prices that is expected to push inflation higher.
Bankers say that hedging activity could accelerate further if the war rages on for several months, raising the prospect of a prolonged rise in oil and gas prices.
"At the end of the day, hedging activity will very much depend on the duration of the conflict,” said Jorge Garayo, head of inflation strategy at Societe Generale. “If the conflict is prolonged then you’re going to see a lot more hedging taking place due to greater rises in inflation expectations implied by the curve.”
The sharpness of bond market moves underline how radically investors have had to adjust their expectations around central bank policy since the outbreak of the war in Iran. Prior to the start of the conflict, traders had anticipated interest rate cuts from central banks this year including the Federal Reserve and the Bank of England.
The surge in energy prices has since prompted investors to scale back those bets. UK government bonds have been among the worst hit ahead of the BoE's monetary policy committee meeting later this month in which traders had previously expected the central bank to lower rates.
The two-year Gilt yield jumped about 20bp on Monday to 4.1% after Brent crude oil futures prices topped US$100 per barrel for the first time since the aftermath of Russia’s invasion of Ukraine in February 2022. Yields have now climbed by more than 50bp since the US and Israel started bombing Iran on February 28.
Barclays strategists said in a Friday note that the BoE's March meeting is now on a "knife edge", although they maintained their call for a 25bp cut. "But if geopolitical uncertainty does not subside, or data come in hotter than we expect, then the balance could easily tip to a hold," the strategists said.
Risk-off
Short-dated eurozone bond yields have also risen sharply over the past week as investors have dumped popular “carry” trades, such as holding Italian and French bonds, and started to contemplate scenarios where the European Central Bank could raise interest rates later in the year.
Benjamin Wiltshire, global inflation trading desk strategist at Citigroup, said the concurrent selloff in bonds and risk assets such as equities has posed a challenge for multi-asset investors.
“Agnostic of any view of elevated energy prices, the propensity for global rates to sell off with risk assets due to inflation concerns reinforces the importance of structural inflation hedges in portfolios,” he said.
Economists at Bank of America said history suggests only marked and persistent spikes in oil prices trigger persistent inflationary cycles.
"The initial base case with oil prices around US$15 higher than the pre-war level was not particularly concerning for inflation," the economists wrote in a note on Monday. "But the most recent escalation leading oil prices to rise above US$100 could become concerning if it proves persistent."