UBS Warns War Could Rattle US Debt Markets
The escalating conflict between Israel and Iran is a new threat to already fragile government debt markets, warns UBS. The bank cautions that increased U.S. military spending and the potential for a prolonged conflict could further destabilize the market, particularly if energy prices remain high.
The U.S. national debt has surged to nearly $38 trillion, with the debt-to-GDP ratio standing at 121%, a significant increase from the 106% peak seen after World War II. This rapid accumulation has seen the debt grow by an average of $6.12 billion per day over the past year. Servicing this ballooning debt has become a major federal expense, with net interest payments surpassing $1 trillion for the first time in fiscal year 2025. These interest costs are now one of the fastest-growing parts of the federal budget, projected to reach $1.039 trillion in fiscal year 2026, exceeding spending on national defense. The government debt market was showing signs of stress even before the latest conflict. The Treasury market's liquidity has been a concern, with periods of abrupt worsening, as seen around the tariff announcements in April 2025. This fragility is compounded by the enormous volume of new Treasury securities that need to be issued to finance the deficit. Historically, Middle East conflicts have triggered a "flight to safety," with investors initially buying U.S. Treasury bonds, which pushes their prices up and yields down. However, prolonged conflicts that lead to sustained high oil prices can also stoke inflation fears, which can have the opposite effect, driving bond yields higher. A Societe Generale analysis of five oil supply shocks over the last 50 years found they weakened 10-year Treasury notes on average. UBS has been highlighting the risks of geopolitical conflict to financial markets. In a 2025 report, the bank noted that a majority of family offices, which manage the wealth of the ultra-rich, saw major geopolitical conflict as a top threat, with 50% specifically worried about a government debt crisis. UBS strategist Dominic Schnider has noted that while geopolitical events can be temporary, they are powerful triggers for volatility that drive investors toward safe-haven assets. Key indicators to watch in the bond market for signs of stress include the yield spread between low-rated corporate "junk bonds" and U.S. Treasuries; a sudden widening of this spread can signal serious financial market dislocations. Another is the bid-to-cover ratio at Treasury auctions, which indicates the strength of demand for U.S. debt.
