Wars and Pandemics Cut Real Returns on Government Bonds by 14% on Average

Why It Matters

The CEPR findings reshape how investors and policymakers view sovereign debt risk. By quantifying the real‑return erosion that wars and pandemics impose, the study highlights inflation and financial repression as structural threats, not merely cyclical concerns. For portfolio managers, the research suggests that traditional safe‑haven assumptions about government bonds may be overstated during geopolitical crises, prompting a re‑evaluation of duration exposure and diversification strategies. For policymakers, the analysis provides empirical backing for the trade‑off between fiscal stimulus and bondholder protection. As the United States confronts a new conflict while its debt burden swells, the temptation to finance spending through inflationary tactics grows. Understanding the historical cost to bondholders can inform more transparent fiscal planning and potentially mitigate long‑term borrowing costs by preserving bond market confidence.

Key Takeaways

• CEPR study of 300 years of U.S. and U.K. data finds average 14% real loss for government bonds in the first four years of wars or pandemics.
• Wars trigger roughly 7% of GDP annual increase in government spending, while tax hikes rarely cover the gap.
• Cumulative inflation during conflicts averages about 20% over the first four years, eroding bond returns.
• Since the U.S. began its Iran conflict, the 10‑year Treasury yield has risen over 40 basis points.
• Policy options that shift spending shocks to bondholders—through inflation or financial repression—may raise future borrowing costs.

Pulse Analysis

The CEPR paper arrives at a moment when the bond market is already grappling with a confluence of fiscal, geopolitical and monetary pressures. Historically, sovereign bonds have been prized for their safety, but the data now suggests that safety is conditional on the macro‑environment. The 14% real‑return drag is not a marginal figure; it eclipses the typical equity risk premium and would have turned a 5% nominal Treasury yield into a negative real return over a war’s early years. This reframes the risk‑return calculus for long‑duration investors, who may now demand higher yields to compensate for the hidden inflationary and repression risk embedded in war‑time fiscal expansions.

From a policy perspective, the study underscores a classic dilemma: the need for rapid, large‑scale spending in crises versus the long‑term health of the debt market. The United States enjoys a unique borrowing advantage as the global reserve‑currency issuer, but that advantage is not infinite. Repeated reliance on financial repression—capped yields, direct purchases, and yield‑curve control—can blunt inflation’s impact in the short run but may also erode market discipline, leading to a steeper yield curve once the repression lifts. Investors are likely to price in a risk premium for future episodes, which could raise the cost of financing wars and pandemics.

Looking ahead, the bond market’s reaction to the current Iran conflict will serve as a live test of the CEPR thesis. If Treasury yields continue to climb and inflation expectations rise, we may see a re‑pricing of sovereign risk that persists beyond the immediate crisis. Asset managers should therefore monitor fiscal announcements closely, incorporate scenario analysis for war‑induced inflation, and consider hedging strategies that protect against real‑return erosion. For policymakers, the study offers a data‑driven argument for transparent financing plans that limit the need for covert inflationary measures, thereby preserving the credibility of government bonds as a cornerstone of global finance.