Are Government Bonds Truly Safe Havens During War? A Historical Reckoning

Key Takeaways

• Historical data spanning 300 years reveals that wars consistently lead to significant real losses for government bondholders due to inflation and financial repression.
• The ongoing US-Israel war in Iran is exacerbating global fiscal concerns, pushing long-term Treasury yields higher and challenging the perceived safety of sovereign debt.
• The U.S. national debt, now exceeding $39 trillion, combined with persistent fiscal deficits, creates a precarious environment for bond investors, amplified by broader geoeconomic fragmentation.

Are Government Bonds Truly Safe Havens During War? A Historical Reckoning

For generations, government bonds, particularly U.S. Treasuries, have been lauded as the ultimate safe haven assets, a bedrock of stability during economic downturns, financial crises, and even geopolitical turmoil. The conventional wisdom suggests that when the world goes sideways, investors flock to the perceived safety of sovereign debt. Yet, a deep dive into 300 years of U.S. and U.K. history reveals a starkly different, and frankly, unsettling reality: wars are consistently "disaster times" for bondholders.

Recent research from the Center for Economic Policy Research (CEPR) meticulously analyzed 250,000 monthly price observations on sovereign bonds dating back to 1822. Their findings are unequivocal: during major wars and even pandemic-scale emergencies like COVID-19, government bonds have repeatedly generated substantial real losses. On average, bondholders experienced real losses of roughly 14% during the first four years of conflicts. This isn't just a minor blip; these losses were significant enough to materially reduce the real value of government debt outstanding.

What's more, these "safe" assets often underperformed riskier investments. Cumulative bond returns were more than 20% below the cumulative returns on equities and real estate after four years into a war. This directly contradicts their typical outperformance during financial crises or recessions, where a "flight to safety" usually sees government bonds rally. The historical record challenges the very notion of government bonds as an unconditional safe asset, revealing their safety is highly conditional on the absence of extreme fiscal shocks.

The primary culprits behind these losses are surprise inflation and financial repression. Wars trigger immense, sudden increases in government spending, averaging about 7% of GDP annually during the first four years of conflicts. Governments rarely meet these colossal financing needs through tax increases alone, leading to inflationary pressures. This historical pattern offers crucial lessons for today's investors, especially as global geopolitical tensions escalate and public debt levels reach unprecedented heights.

How Do Wars Undermine Sovereign Debt? Inflation and Financial Repression

The mechanisms through which wars erode the value of government bonds are well-documented throughout history, primarily revolving around inflation and financial repression. When nations engage in large-scale conflicts, the immediate and overwhelming need for funding often outstrips traditional revenue streams. Governments are forced to borrow heavily, leading to a surge in public debt and, crucially, a shift in monetary policy.

Historically, cumulative inflation averaged about 20% over the first four years of wartime episodes in the U.S. and U.K. While nominal bond returns might remain positive, this surge in inflation drastically erodes their real purchasing power. This isn't merely an unfortunate side effect of economic disruption; it often reflects deliberate policy choices. Governments, facing immense unfunded spending, allow inflation to act as an implicit tax on holders of nominal government debt. For instance, both the U.S. and U.K. repeatedly abandoned or suspended gold standard commitments during major wars, increasing monetary flexibility and allowing inflation to rise as a means to reduce debt burdens without explicit default.

Beyond inflation, financial repression plays a critical role. This refers to government policies that curb borrowing costs by influencing financial markets, preventing bond yields from keeping pace with inflation. A classic example is the Federal Reserve's implementation of yield-curve control, capping Treasury rates, and launching massive bond-buying programs during World War II. These interventions effectively lowered nominal interest rates even as inflation increased, resulting in negative real returns for bondholders. The combination of rising prices and suppressed yields generated substantial real losses, an implicit transfer from bondholders to taxpayers.

These historical patterns demonstrate that the apparent safety of government debt is conditional. It depends not only on credit default risk but also on governments' willingness to preserve the real value of debt during extreme fiscal shocks. When interest rates are dramatically suppressed below economic growth during crises, it's not necessarily a sign of easy debt sustainability, but rather a reflection of these implicit transfers from bondholders.

What is the Impact of the Current Geopolitical Climate on Global Bonds?

The lessons from history are not confined to dusty archives; they are playing out in real-time across global financial markets. The ongoing US-Israel war in Iran, which began on February 28, has rapidly whipsawed markets, with investors increasingly factoring in the prospect of a prolonged conflict. This new geopolitical reality is directly impacting sovereign bond markets worldwide, driving up yields and raising serious concerns about fiscal stability.

Since the war's inception, the U.S. 10-year Treasury yield has soared more than 40 basis points. As of March 20, 2026, the 10-year Treasury yield stands at 4.39%, with the 30-year yield at 4.96%. This surge in long-term yields is a direct response to two major factors: the inflationary impact of rising oil prices and mounting worries about fiscal deterioration. The market is anticipating that governments will need to borrow significantly more to fund defense spending and shield households from higher energy costs, leading investors to demand greater compensation for holding longer-dated bonds.

This phenomenon isn't limited to the U.S. Global bonds have surrendered their year-to-date gains, with yields spiking from the U.K. to Germany, Australia, and Japan. Even in China, where markets have been a relative haven, longer-dated bonds have come under pressure, with 30-year yields reaching their highest since 2024 due to inflation fears. European governments, recalling their 2022 "playbook" during the energy crisis, are already contemplating interventions and potential joint EU issuance to fund crisis spending, which would further swell deficits.

The U.S. budget deficit, while having narrowed recently, still totaled around $1 trillion in the five months through February. However, investors are now factoring in the costs of the Iran war, with discussions of as much as $50 billion in additional funding already underway in Congress. White House economic adviser Kevin Hassett estimated the war has cost the U.S. over $12 billion so far. This confluence of war-related spending, inflationary pressures, and existing fiscal challenges creates a volatile cocktail for fixed-income investors globally.

Is the U.S. National Debt an Unstoppable Force?

The U.S. national debt has become a runaway train, recently surpassing a staggering $39 trillion just weeks into the US-Israel war in Iran. This grim milestone arrived less than five months after hitting $38 trillion, and only two months after reaching $37 trillion. This rapid pace of accumulation has budget watchdogs unanimously labeling the trajectory as "unsustainable." The Peterson Foundation projects the debt will cross $40 trillion before this fall's elections, highlighting a critical lack of a credible plan to rein in U.S. fiscal deficits.

The sheer scale of this debt is alarming, particularly when considering the broader fiscal gap. When unfunded entitlements like Social Security and Medicare are factored in, the true liability approaches $100 trillion. The Congressional Budget Office (CBO) projects the federal deficit will reach $1.9 trillion in fiscal year 2026 and balloon to $3.1 trillion by 2036. Debt held by the public, currently at $31.3 trillion, is on track to hit 120% of GDP within a decade, eclipsing the post-World War II record.

Perhaps most concerning are the escalating costs of servicing this debt. Net interest payments on the national debt have already exceeded $1 trillion in fiscal year 2026, nearly triple the $345 billion paid in 2020. Interest payments have even surpassed defense spending in the first three months of the fiscal year alone, making interest the fastest-growing "program" in the federal budget. This creates a feedback loop where rising debt leads to higher interest payments, which in turn add to the deficit and necessitate more borrowing.

While some argue that the U.S. issues debt in its own currency and benefits from the dollar's reserve currency status, allowing it to sustain higher debt levels, this perspective overlooks the potential for a crisis of confidence. As former diplomat Richard Haass warned, the relevant question isn't just the size of the debt, but what conditions could finally break investor confidence. These conditions are as much about governance and geopolitical credibility as they are about balance sheet figures. The current environment of escalating conflict and persistent deficits tests the limits of this "exorbitant privilege."

Geoeconomic Fragmentation: The Broader Risk to Markets

Beyond the direct costs of war and ballooning national debt, the current geopolitical climate is ushering in an era of "geoeconomic fragmentation," identified by the World Economic Forum (WEF) as the top global risk for 2026. This isn't merely about armed conflicts; it's the "weaponization" of economic tools—tariffs, sanctions, export controls, and currency measures—to achieve geopolitical objectives. For investors, this translates into a multi-channel shock mechanism that can hit revenue, costs, liquidity, and supply chains simultaneously.

This evolving geopolitical risk has more lasting implications than the short-term market volatility typically associated with past shocks. A move toward global trade protectionism could fundamentally alter investment risk profiles, forcing companies to build manufacturing capacity in higher-cost locations. This fracturing could lead to less international cooperation, resulting in bottlenecks and resource hoarding in critical raw materials or manufacturing inputs. The predictable outcome: potentially higher inflation, more frequent supply shocks, and increased bouts of market volatility over the longer term.

One significant consequence of this fragmentation is the potential for a shift away from dollar-denominated assets. While foreign investors have remained net buyers of U.S. equities and bonds over the 12 months ending November 2025, the trend of countries diversifying away from the U.S. by building trade alliances is accelerating. Should sustained U.S. government debt concerns trigger further U.S. dollar weakness, it could increase returns in international stocks and potentially lead to upside for gold prices, as investors grow uneasy with the U.S. fiscal trajectory.

The channels of disruption are directly commercial: trade friction, financial sanctions, technology export controls, and commodity/energy supply shocks. Businesses face rising compliance burdens, operational fragility due to concentration risks, and political risks translating directly into P&L impacts. This double squeeze—rising costs combined with weakening demand—underscores the need for investors to consider how geopolitical fracturing will reshape global markets and asset allocation strategies in the coming years.

What Does This Mean for Investors? Navigating a Volatile Landscape

The confluence of historical patterns, current geopolitical realities, and an escalating U.S. national debt paints a challenging picture for fixed-income investors. The notion of government bonds as an unconditional safe haven is being severely tested, particularly for longer-dated maturities. Investors must acknowledge that during times of major conflict and fiscal stress, real returns on sovereign debt can be significantly negative, and these assets may even underperform traditional "risky" assets like equities and real estate.

Given the current 10-year Treasury yield at 4.39% and the 30-year yield at 4.96%, and an inflation rate of 2.37%, real yields are positive, but the risk of future inflation spikes due to war spending and financial repression remains a significant concern. The market is already demanding higher risk premiums for long-dated securities, with some analysts suggesting little interest in the 30-year Treasury until it's "north of 5%." This indicates that current yields may not fully price in the long-term fiscal and inflationary risks.

For bond investors, a diversified approach is more critical than ever. Consider shorter-duration bonds to mitigate interest rate risk, or explore inflation-protected securities (TIPS) if you believe inflation will accelerate. Allocations to assets traditionally seen as hedges against inflation and geopolitical instability, such as gold, might also warrant consideration. The historical underperformance of bonds relative to equities and real estate during wartime also suggests a re-evaluation of portfolio construction, perhaps favoring real assets or equities in sectors that benefit from increased defense spending or reshoring trends.

The evolving landscape of geoeconomic fragmentation also necessitates a global perspective. While the U.S. dollar may face long-term headwinds, other developed and emerging market international stocks could offer opportunities. Investors should stress-test their portfolios against scenarios of managed fragmentation, escalation spirals, and financial tightening. The key takeaway is that resilience in this environment comes not from predicting the future, but from having well-prepared options and a diversified strategy that accounts for both the direct and indirect impacts of a more fragmented and conflict-prone world.

The current geopolitical climate and the relentless rise of national debt are fundamentally reshaping the investment landscape for government bonds. Investors must move beyond outdated notions of unconditional safety and adopt a nuanced, historically informed perspective. Diversification, a focus on real returns, and a keen eye on fiscal policy and geopolitical developments will be paramount for navigating the volatile years ahead.

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