Watch The World Burn

The War, Financial Markets, And Why Bunds Could Be In Danger

Note: The report was written on June 18

God told me to end the tyranny in Iraq. – George W. Bush

Geopolitics dominates conversation these days, especially since Israel launched what it calls a preemptive strike on Iran. While some in the West celebrate the attack and cheer for war, I can’t shake the feeling that it’s 2003 all over again.

What happened in 2003? The US invasion of Iraq. Back then, most Europeans opposed it, except for Tony Blair and the UK, who eagerly followed their ally, the US, into conflict. Leading up to the war, the US ran a massive campaign claiming Saddam Hussein was secretly developing weapons of mass destruction, was allied with Al-Qaeda, and needed to be overthrown.

Back then, no one pushed for war louder than Benjamin Netanyahu. In 2002, he told the US Congress,

If you take out Saddam’s regime, I guarantee it will have enormous positive reverberations on the region.

We all know how that turned out: massive loss of life—men, women, and children—and a civil war that destabilized the region. While no one can predict how things in Iran will unfold, I’m skeptical of claims that "this time will be different." From what I’ve read, the war’s goal has already shifted from "Iran can’t have nukes" to "regime change will solve everything."

That’s the war hawks’ usual pitch. Yet, it rarely plays out as promised. Even the claim that Iran is months away from a nuclear weapon seems dubious. Netanyahu has been saying this since at least 1995. US intelligence, per CNN, estimates Iran is still years away from a deliverable nuclear weapon, according to four sources familiar with the assessment.

True, Iran has enriched more uranium to 60% purity, close to the 90% needed for weapons-grade material. But building a functioning warhead and a missile to deliver it is another matter. Israel’s preemptive strike has likely heightened Iran’s incentive to pursue a bomb, leaving regime change—and full US involvement—as the apparent "solution."

To be clear, Iran’s regime is tyrannical, and there are moral arguments for its removal. But the track record of US-led regime changes in Iraq, Libya, Sudan, and Syria is abysmal. The odds of a better outcome here seem slim.

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Now, let’s consider the war’s impact on the global economy and financial markets. When the conflict began, investors briefly bid up government bonds while stocks dipped. The bond rally was short-lived, with safe-haven assets like US Treasuries and German Bunds selling off soon after. Stocks have since stabilized, trading sideways. The dollar hasn’t moved much either, with EUR/USD at 1.1518, roughly where it was pre-war.

Not all markets were unaffected, though. Oil (WTI) jumped about $5 per barrel to $74.59. As Jim Bianco of Bianco Research noted:

…markets are NOT viewing Israel/Iran as a safe-haven event, but rather a crude oil supply shock story. In other words, this is NOT seen as the start of WWIII.

If that assumption proves wrong, history suggests stocks might still hold up. In apocalyptic scenarios, owning stocks becomes irrelevant; stocks could rally if the fears are overblown. This aligns with other data supporting a bullish outlook for equities.

Bonds, however, face a different story. War is inflationary, and bond yields often rise in such times. After Russia invaded Ukraine, yields spiked due to inflation pressures.

Oil traders worry about disruptions in the Strait of Hormuz, a critical chokepoint for global oil shipments. But since China, an Iranian ally, relies heavily on the strait, Iran is unlikely to block it. Israel’s rapid air superiority over Iran further suggests a blockade wouldn’t last. For now, oil prices seem unlikely to keep climbing.

The resilience of stocks near recent highs signals the bull market isn’t over. Notably, junk-rated companies are accelerating debt sales, meeting robust investor demand. This ease of borrowing suggests a wave of liquidity that could lift the economy, potentially driving growth beyond current expectations. This reinforces my view from last week: the US economy is accelerating.

Rising oil prices and liquidity inflows will likely keep inflation elevated, leaving bonds vulnerable. The Middle East conflict strengthens the case for higher long-term bond yields. As I noted last week, expectations of lower US tariffs post-"Liberation Day" and ongoing deficit spending could sustain elevated prices, boosting nominal growth and yields.

In the Eurozone, the picture is similar for stocks and bonds. Germany’s era of fiscal restraint is over, signaling to the rest of the Eurozone that deficit spending is back. The Financial Times quoted Tammo Diemer, an executive at Germany’s finance agency, saying the scarcity of Bunds is history. More deficit spending means a greater supply of Bunds for markets to absorb. Trump’s tariff confusion has driven some bond buyers to diversify away from the dollar, boosting demand for euro-denominated bonds.

Bloomberg reports that US importers’ foreign counterparties increasingly prefer euros, Chinese renminbi, Mexican pesos, or Canadian dollars to avoid US-dollar volatility. This has strengthened the euro, contributing to a divergence in yield differentials between US Treasuries and Bunds and the exchange rate. As long as demand keeps pace with the rising supply of Bunds, their prices should hold steady, explaining why German Bunds have barely moved in the past month.

However, the European Central Bank (ECB) is doubling down on this trend. In a recent opinion piece, ECB President Christine Lagarde argued that protectionism could elevate the euro’s global status. Again, she advocated for joint EU financing:

For the euro to gain in status, Europe must take decisive steps by completing the single market, reducing regulatory burdens and building a robust capital markets union. Strategic industries, such as green technologies and defence, should be supported through co-ordinated EU-wide policies. Joint financing of public goods, like defence, could create more safe assets.

Yet, at the ECB’s latest press conference, she urged governments to reduce spending—a contradictory stance.

History shows governments rarely cut deficits unless markets force them, as during the Eurozone debt crisis. Joint EU debt issuance is more likely to increase domestic spending, driving up Bund yields and other EU government bonds. Policymakers seem confident that the euro’s strength and market demand will absorb this debt surge.

This is why I believe German Bunds are more vulnerable than US Treasuries as we advance. The euro’s appreciation has kept Bund yields in check, with a negative correlation between EUR/USD and Bund yields since "Liberation Day."

But if the dollar strengthens and investors shift euros back to dollars, demand for Eurozone bonds could drop. This could trigger a chain reaction: a stronger dollar, stable US Treasury yields, and sharply higher Bund yields, leading to a broader rise in global yields.

Eurozone governments might honestly "watch the world burn” if that happens.

Watch the world burn,
It sets the air on fire!
Watch the world burn,
We are the arson!

Trivium – Watch The World Burn

Have a great weekend!

Fabian Wintersberger

NOTE: Next week, there’ll be no “Weekly Wintersberger”

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All my posts and opinions are purely personal and do not represent the views of any individuals, institutions, or organizations I may be or have been affiliated with, whether professionally or personally. THEY DO NOT CONSTITUTE INVESTMENT ADVICE, and my perspective may change over time in response to evolving facts. IT IS STRONGLY RECOMMENDED TO SEEK INDEPENDENT ADVICE AND CONDUCT YOUR OWN RESEARCH BEFORE MAKING INVESTMENT DECISIONS.