There is a well-known pattern in the history of financial markets: investors are exceptional at pricing the knowable and likely, but terrible at recognizing when the world fundamentally shifts. We are living in that moment now.
We are witnessing a structural recalibration of the global order—a regime change driven not by a single shock, but by multiple factors playing out simultaneously. The U.S. is rewriting the rules of global trade and finance. Globalization as we knew it is effectively over, which means the disinflationary forces that anchored inflation and interest rates for decades are now gone. An AI capex boom is creating unprecedented demand for physical assets, commodities and energy. Governments are being forced to prioritize supply-chain resilience and security in ways unseen since the Cold War.
Markets are not good at identifying inflection points in real time. We extrapolate backward, pricing in yesterday’s regime until the evidence becomes overwhelming. By then, capital has been misallocated and policymakers are playing catch-up. The global sell-off in rates in recent days should be evaluated in this context.
The Middle East Conflict Crystallizes a New Reality
The Middle East conflict is forcing investors to price a fragmenting world—not as an abstract possibility, but as an unfolding reality with immediate implications for asset prices and monetary policy.
Government bonds sold off across the developed world in mid-May, reflecting in part a reassessment of outlook for monetary policy. The U.S. economy remains resilient; first-quarter earnings were blockbuster with double-digit growth expected this year, and consumers kept spending. Against this backdrop, keeping central bank policy rates unchanged amounts to a stealth easing as inflation rises and real rates mechanically decline.
What is driving the sell-off is the realization that priorities in this new regime are different, and they come with a cost. The conflict has accelerated a reordering from efficiency (just-in-time inventory) to resiliency (just in case inventory management, which can turn into hoarding under stress). The weaponization of choke points along supply chains—from AI to rare earths to oil and other commodities—will be a focal point in the future.
This pivot has potentially significant inflationary implications. Look at the turmoil in energy and commodity markets: Brent-WTI spreads are wide and volatile, as are spreads along the refining stack. Shipping routes are under threat, and disruptions in the aluminum industry persist. The risk is that these frictions cause not just elevated prices and volatility but eventually shortages, especially as the Strait of Hormuz remains closed.
Government bonds sold off across the developed world in mid-May, reflecting in part a reassessment of outlook for monetary policy. The U.S. economy remains resilient; first-quarter earnings were blockbuster with double-digit growth expected this year, and consumers kept spending. Against this backdrop, keeping central bank policy rates unchanged amounts to a stealth easing as inflation rises and real rates mechanically decline.
What is driving the sell-off is the realization that priorities in this new regime are different, and they come with a cost. The conflict has accelerated a reordering from efficiency (just-in-time inventory) to resiliency (just in case inventory management, which can turn into hoarding under stress). The weaponization of choke points along supply chains—from AI to rare earths to oil and other commodities—will be a focal point in the future.
This pivot has potentially significant inflationary implications. Look at the turmoil in energy and commodity markets: Brent-WTI spreads are wide and volatile, as are spreads along the refining stack. Shipping routes are under threat, and disruptions in the aluminum industry persist. The risk is that these frictions cause not just elevated prices and volatility but eventually shortages, especially as the Strait of Hormuz remains closed.
Inflation Revives
U.S. inflation has remained stubbornly above target since the pandemic and, with the world facing yet another supply shock, structural forces are kicking in. Investors no longer expect Federal Reserve rate cuts; market pricing now reflects a potential rate hike by mid-2027. That’s a significant recalibration from early March.
The AI capex boom is inflationary in the short term: shortages of skilled labor, rising semiconductor demand, and surging energy needs are making their way into inflation measures. Will it be disinflationary medium-term as AI services become competitive? Perhaps. But the near-term trajectory is likely upward.
A more troubling observation is that mercantilist policies—direct government management of the economy beyond tariffs—are gaining traction globally. Fiscal priorities are shifting toward defense and infrastructure across advanced countries, requiring significant financing and likely to be inflationary.
The AI capex boom is inflationary in the short term: shortages of skilled labor, rising semiconductor demand, and surging energy needs are making their way into inflation measures. Will it be disinflationary medium-term as AI services become competitive? Perhaps. But the near-term trajectory is likely upward.
A more troubling observation is that mercantilist policies—direct government management of the economy beyond tariffs—are gaining traction globally. Fiscal priorities are shifting toward defense and infrastructure across advanced countries, requiring significant financing and likely to be inflationary.
The Bond Market Spreads
In addition to a reassessment of the outlook for monetary policy, the sharp rise in long-term interest rates appears to be driven by higher term premia—a reflection of both higher inflation uncertainty and fiscal concerns.
What makes this moment challenging for markets and policymakers is “Knightian uncertainty”—a situation where the probability of possible outcomes is not quantifiable. Financial conditions are easy and financial markets, though fragmented, can still transmit shocks globally. Central bank communication becomes harder.
What makes this moment challenging for markets and policymakers is “Knightian uncertainty”—a situation where the probability of possible outcomes is not quantifiable. Financial conditions are easy and financial markets, though fragmented, can still transmit shocks globally. Central bank communication becomes harder.
Challenges Ahead
Diversification becomes paramount as the old playbook of capital allocation based on seamless global linkages and tight relationships between markets has been overthrown.
Investors need to think about which assets benefit from resilience-focused policies and which perform well in a world of elevated inflation, higher rates, and larger security premiums.
Interpreting asset price signals is critical. Valuations are stretched in equities and credit, and concerns about private credit continue to mount. AI euphoria continues even questions about the risk of a tech-driven bubble grow. At a time when experts abound in social media, the lessons of history can help separate the signal from the noise.
The pricing of the new world is only starting. The question is whether it happens smoothly or in a nonlinear, disruptive way. History suggests regimes don’t change quietly. The recent sell-off in global yields could be just the opening chapter.
Investors need to think about which assets benefit from resilience-focused policies and which perform well in a world of elevated inflation, higher rates, and larger security premiums.
Interpreting asset price signals is critical. Valuations are stretched in equities and credit, and concerns about private credit continue to mount. AI euphoria continues even questions about the risk of a tech-driven bubble grow. At a time when experts abound in social media, the lessons of history can help separate the signal from the noise.
The pricing of the new world is only starting. The question is whether it happens smoothly or in a nonlinear, disruptive way. History suggests regimes don’t change quietly. The recent sell-off in global yields could be just the opening chapter.
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