Positioning your fixed-income portfolio amid war
Sometimes the best offence is a very strong, high-quality defence
THE global investment landscape shifted fundamentally in late February 2026. What began as a series of targeted military exchanges between the US-Israel coalition and Iran has evolved into a systemic threat to global energy security. For fixed-income investors, the narrative has pivoted from a “flight to safety” to a more complex struggle against “oil-flation”.
Anatomy of a supply shock
The conflict reached a critical point following strikes on Iran’s strategic assets. In retaliation, Iran announced the effective closure of the Strait of Hormuz – a narrow but vital maritime passage that carries roughly 20 per cent of the world’s seaborne crude oil and a significant portion of liquefied natural gas.
The market reaction was instantaneous. Oil prices surged and have remained elevated despite a record-breaking coordinated release of crude oil reserves from the International Energy Agency, a group of major oil-consuming nations. This highlights the market’s deep-seated anxiety over a prolonged blockade.
Beyond the sea, the “bridge” between East and West has been compromised. Airspace closures across the Gulf have forced the suspension of operations at global transit hubs, including Dubai, Abu Dhabi, Bahrain and Doha.
This effectively severs the primary air link between Europe and Asia. With no clear sign of an end to this conflict, the market is now pricing in a prolonged disruption to global commerce.
For fixed-income portfolios, this event complicates the global interest rate narrative, namely the expectation that central banks will keep cutting/holding interest rates. The primary concern now is that higher energy costs will stall the “last mile” of disinflation progress or even reignite inflationary pressures once again.
According to US Federal Reserve research in 2023, a 10 per cent increase in oil prices can raise US inflation by nearly 0.4 per cent. This includes the immediate jump in energy costs and the “second-round effects” as higher costs seep into the price of food and goods.
International Monetary Fund managing director Kristalina Georgieva also recently mentioned that a 10 per cent increase in energy prices could push global inflation similarly by 40 basis points.
Since the start of March 2026, the US two-year Treasury yield has climbed roughly 40 basis points, testing the 3.7 per cent mark. This pickup in yield reflects a market recalibrating for a “higher-for-longer” interest rate environment, where investors are pricing in the reality that central banks cannot afford to cut rates while surging oil prices threaten to reignite inflation.
The impact is even more pronounced for sovereign issuers with heavy reliance on imported energy. European and Asian sovereigns might be more vulnerable, as markets factor in the twin pressures of rising import costs and the possibility of a weakening growth outlook.
In the corporate bond market, we are seeing a clear divergence in credit spreads. Investment-grade spreads have widened only slightly as these issuers generally possess the balance sheet strength to absorb higher input costs.
On the other hand, high-yield spreads have seen a more aggressive widening, as investors price in the risk of credit weakening for smaller or more leveraged firms that might face a more uncertain revenue backdrop.
The latest employment data added a layer of complexity: US non-farm payrolls (a measure of jobs added to the economy) fell unexpectedly by 92,000, the largest decline in months, and the unemployment rate ticked up to 4.4 per cent.
This creates a difficult paradox for central banks. A cooling labour market usually calls for lower interest rates to support growth. However, soaring energy prices demand a restrictive stance to keep inflation in check.
As at Mar 12, investors are bracing for a higher-for-longer interest rate landscape, with no rate cut priced in for 2026. We continue to expect the Fed to adopt a “data-dependent” approach, watching monthly figures closely rather than committing to a set path of rate cuts.
In this volatile environment, our investment strategy centres on two simple rules: Focus on quality bonds and be selective. We continue to prefer medium-duration US and Singapore government bonds (five to 10 years). This “sweet spot” offers better yields than short-term bonds without the risks of going too far out on the yield curve.
That said, we do not see the need to rush out from short-term bonds (one to three years) just yet. They still offer attractive yields which are not expected to fall too much (assuming no aggressive Fed cuts), providing a “waiting room” while the geopolitical fog clears.
On the corporate bonds side, we maintain a disciplined tilt towards investment-grade issues in both markets. With yields now hovering in a more attractive range, these bonds are underpinned by solid corporate fundamentals. Their resilience, evidenced by relatively contained spread widening and historically low default risks, provides a vital layer of defensiveness and stability for portfolios navigating this period of heightened tension.
While the Middle East conflict has introduced a new bout of volatility across the investment landscape, we believe that by maintaining a focus on credit quality, embracing appropriate duration positioning, and diversifying across geographies and sectors, portfolios can weather near-term volatility while positioning for medium-term normalisation.
We reiterate our stance that five to 10-year tenors of US and Singapore government bonds and investment-grade bonds are the sweet spot for your fixed-income portfolio. In fixed income, sometimes the best offence is a very strong, high-quality defence.
The writer is a research analyst of the global fixed income team at FSM Global, the B2C division of iFast Financial, a subsidiary of iFast Corporation.
