In the US, the steepener has become the consensus trade, as has setting long end shorts. Price action through Thursday went against that grain; lower yields and a flatter curve; with month-end duration extension being a catalyst. The curve should steepen on near-term disinflationary risks, whereby the back end is anchored higher on fiscal spending
US yields find an excuse to ratchet a tad lower, against the grain of the crowded steeper
Thursday saw firmer US data than anticipated. Second-quarter was revised up a smidgen to 3.3% (from 3.1%). These data have been distorted by net import gyrations on the back of the tariff games being played by importers. The same swings can be seen in inventories. was quite tame, though, at 1.6%, which is a better measure of where the economy really is (technically a growth recession). came in at 229k, and the previous week was revised down. The same for . Stop the music here, and these claim numbers are actually a sign of a solid labour market.
Yields across the board were a tad up on the back of this. However, it seems the market is primed for steepeners and long-end short positioning. As the day progressed, the path of least resistance was to push against that, and ultimately, long-end rates managed to ease off highs.
Month-end duration extensions have been a catalyst, but the price action so far has tended to go beyond simply that. But can also mean some more of the same on Friday. That said, we stick with the steepening view from both ends as our preferred stance in the coming weeks.
We also had a reasonably decent auction. It tailed slightly (auction yield came slightly above secondary), but that was into a firm market, which raises the tendency to tail. Dealers took down less than 10%, which is good. The indirect bid (includes central banks) dominated, reversing the trend seen in the and auctions, where the direct bid (where most domestics come in) was firmer than usual. All in all safely away. The next big impulse comes from Friday’s inflation readings.
Euro Rates Risk Getting Carried Away by Falling Inflation
In the eurozone, while price pressures seem well behaved, we identify undershooting as a key tail risk to our rates outlook. Friday’s inflation numbers are unlikely to swing markets, but a series of lower-than-expected figures could reverse some of the recent upward pressure on rates.
The short end of the curve is especially vulnerable to a shift lower as markets are now pricing in just 18bp of European Central Bank easing by mid-2026, which is not even a full cut. Having said that, inflation fixtures already account for a period of inflation well below the 2% target.
As fiscal impulses start ramping up, the medium-to-longer term inflation outlook should remain firm, keeping upward pressure on the back end of the curve. This also seems the consensus from the ECB’s June meeting minutes, although the inflation outlook is a topic of debate. In our baseline we think the curve should turn towards hiking mode by the end of 2026 or beginning of 2027 as inflation reverts above target again. As a result, the 10Y swap rate should find itself moving higher from here, steepening the curve.
The question is whether markets can maintain a bearish view on longer rates against a backdrop of falling inflation numbers. European investors are still traumatised by the secular stagnation environment from pre-COVID, one in which inflation was well below target. As such, markets may extrapolate downside inflation surprises too far out in the future, which would then pull down the entire curve. Again, this is not our baseline but is a tail risk we should be aware of.
Friday’s Events and Market View
Germany, France and Spain will release preliminary inflation data for August where the market is looking for slightly higher year-on-year readings compared to last month. Economic sentiment indicators for the eurozone will be watched as to whether they will confirm the somewhat more upbeat take on the economy presented by the recent PMIs. The ECB will publish the consumer inflation expectations survey for July.
In the US the focus will fall on the price index, the Fed’s favoured inflation measure. The year-on-year rises are expected to come in at an unchanged 2.6% for the headline and a slightly higher 2.9% for the . Our economists think there is a risk for a slightly cooler reading than the consensus 0.3%:
Despite very hot producer price figures, the components that feed directly from that release into core PCE were more mixed. Personal income and spending data as well as the final University of Michigan will round off the US releases. The Fed’s Waller will speak on monetary policy.
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