The New Role of Geopolitical Risk in Bond Investing

Interest rate volatility is reshaping bond markets. We examine why geopolitical risks have become increasingly linked to bond market volatility since 2025, and discuss the implications for the term premium, fixed income positioning and investment opportunities.

Highlights

• Geopolitical risk has become a more important driver of bond-market volatility. In the last two years, the relationship between the two has strengthened materially.
• The novelty is not the quantity or size of geopolitical shocks; it is their quality. Recent shocks differ from traditional ones because they have originated in the U.S. and have been inflationary for the U.S.
• While traditional geopolitical shocks tended to compress the term premium and yields on U.S. Treasuries, recent shocks have pushed both higher, resulting in a novel and magnified effect on bond yields. This is one of the reasons why long-term bond yields remain elevated despite lower rate-volatility expectations.
• We describe the current environment as one of “Predictable Volatility.” Geopolitical tensions may generate repeated market swings, but the most likely endgame remains gradual de-escalation rather than permanent escalation.
• For investors, volatility is increasingly an opportunity as well as a risk. Headline-driven sell-offs and rallies can create attractive trading opportunities, particularly in a broadly range-bound rates environment. Rather than simply being a threat, geopolitical risk has become increasingly tradable.

Theoretical Underpinnings

First, let’s start by understanding and defining the term premium. Assuming a near-zero risk of the U.S. government defaulting on its debt, the yield of a 10-year U.S. Treasury (UST, henceforth) should be determined by the central bank policy rate expected to prevail over the next 10 years (the “compound short rate”), plus a “term premium” compensating investors for taking interest rate risks (i.e., the risk of holding a bond for 10 years instead of investing in an overnight loan reinvested every day for 10 years).

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