Citadel Securities has argued that while surging energy prices and tighter monetary policy from the European Central Bank have driven European bond yields higher, these same forces could ultimately cap further upside. The reasoning is that elevated energy costs and high interest rates will place greater strain on European economic growth, and as investors increasingly focus on slowdown or even stagflation risks, the scope for a continued significant rise in European rates may be limited.

Last week, European and UK bonds were hit particularly hard amid a global bond market selloff. The ECB raised rates again, citing rising inflation risks, which further fueled market expectations for additional tightening. Meanwhile, given Europe's heavy reliance on imported energy, the surge in energy prices resulting from the Iran conflict has led investors to bet that the ECB may need to hike rates further to curb inflation.

However, Nohshad Shah, Head of Fixed Income Sales for Europe, the Middle East and Africa at Citadel Securities, believes the market may be underestimating the negative impact of the energy shock and monetary tightening on European economic growth, and this growth pressure could eventually constrain rate increases. "As the growth consequences of tightening and the energy shock become more of a focus for investors, I increasingly doubt that forward rates in the middle of the European yield curve can continue to rise," Shah said.

Divergence in Economic Resilience Between the US and Europe, with US Yields Potentially Having More Upside

Compared with Europe, Citadel Securities believes the US economy is better positioned to withstand high energy prices and high interest rates, leaving more room for US rates to rise. Although rising energy costs and inflation concerns have also pushed US Treasury yields higher, the US benefits from a vast oil and gas industry, making it less sensitive to imported energy price increases than Europe. At the same time, the ongoing boom in artificial intelligence investment is providing additional support to the US economy, allowing it to tolerate higher rates for a longer period.

Shah noted that the US is "better able to absorb high rates" than Europe, where the risk of stagflation is more pronounced. This divergence in economic fundamentals could ultimately be reflected in the performance of US and European rate markets. Shah believes that as growth pressures emerge, European medium-term forward rates may decline relative to those in the US. In other words, even though both US and European bonds have recently been affected by the energy shock and inflation concerns, the trajectory of yields in the two regions may gradually diverge.

For Europe, rising energy prices not only push up inflation but also increase costs for businesses and households, erode real purchasing power, and weigh on economic activity. Meanwhile, the ECB's further rate hikes to control inflation add additional pressure on demand by raising financing costs. This means the ECB faces a more pronounced policy dilemma: continued tightening helps curb inflation but risks further undermining growth. Therefore, the factors that have recently pushed European bond yields higher could also become forces that suppress them. Once market focus shifts from "inflation forcing central bank hikes" to "high rates and energy shock dragging on the economy," investor expectations for further European rate increases may cool.

The Iran Conflict Remains the Biggest Wildcard, and US Inflation Risks Cannot Be Ignored

However, Shah also cautioned that the US is not entirely immune to the energy shock. With the Iran conflict ongoing, the risk of an oil price shock remains elevated. He believes that with US midterm elections approaching, Tehran may have stronger incentives to expand the conflict, including actions against commercial shipping and energy infrastructure in the Middle East. If the conflict escalates further, global oil and gas supplies face more severe disruptions, and energy prices could continue to rise, intensifying US inflationary pressures.

Citadel Securities' assessment of US and European bond markets does not suggest that European inflation risks have subsided, but rather that Europe's economy is less able to withstand the simultaneous occurrence of an energy shock and high interest rates. The US, supported by its domestic energy industry and the economic boost from the AI investment boom, may have greater policy and growth buffers. This also implies that after the recent global bond selloff, US and European rate trends may gradually diverge: further upside in European yields could be constrained by weak growth and stagflation risks, while if the US economy continues to show resilience, coupled with elevated energy prices, US Treasury yields may face more sustained upward pressure.