Rates Spark: Bonds Back To Hedging Market Risks

Lower oil prices should give investors more confidence in holding bonds as a hedge against equity downturns. If AI jitters were to challenge broader sentiment, and even turn into an economic risk, we could see demand for rates pick up. Meanwhile, the EU has confirmed that total funding demand for this year will increase from €160bn to €180bn

Bonds once again an attractive hedge against market jitters

The prospect of a deal between the US and Iran helped market optimism, but AI jitters might be the next source of rates volatility. On the equities side, we see that implied volatilities shot higher, with the VIX close to 20 again. Overall, indices continue to trade close to record highs, but we do see more idiosyncratic sell-offs with the SpaceX IPO being the most prominent one. The hawkish tilt from the Fed does not help either, and a drift higher in longer real rates can be a challenge to valuations.

With US macro data still showing resilience, the Fed won’t be quick to respond to turmoil in the equities market, but is not entirely immune either. PMIs on Tuesday were well above 50, which is consistent with the earlier robust payroll numbers. Having said that, much of the economy is being pulled by AI-related investments. Mounting concerns about AI’s earning potential can therefore easily turn into a real economic drag. In addition, a sharp decline in share prices would hurt the already fragile consumer confidence. In such scenarios, the markets’ assessment of two more Fed hikes seems well overdone.

And with oil prices coming down, bonds should start looking more attractive as a risk hedge. A few weeks ago we noticed the record positive correlation between bonds and equities. But the correlation should start to normalise going forward. The recent push higher in rates was more driven by real rates than inflation expectations. If growth concerns were to take over now, we can expect those real rates to revert lower. In this case, the gains in bonds would offset equity losses, restoring the negative correlation.

EU confirms €80bn funding plan for the second half of the year

At the start of the week, the EU concluded its €100bn bond funding for the first half of the year with a final auction raising €7.8bn. Now the EU has confirmed the funding plan for the second half at €80bn, to reach a total of €180bn for the year. Following the adoption of the Ukraine support package, the EU had already earlier this year indicated an increase of its initial €160bn funding plan by €20bn.

Four syndications and six auctions are planned for the second half of the year. In terms of new conventional bond lines to be launched, the EU has flagged 3y, 5y, 15y and 30y lines, which are also broadly in line with market expectations. This follows launches of 3y, 7y, 10y and 20y lines in the first half.

Wednesday’s events and market views

Germany will publish new Ifo survey readings, which will hopefully show a more notable recovery than the disappointing PMIs for June. Data from the US includes the current account balance for first quarter 2026 and new home sales for May. Both are unlikely to be notable market movers.

In terms of supply, the UK will auction a £4.25bn 5y gilt. Italy will auction 2y BTP and 13y BTPei totalling €4.25bn. Germany will auction 11y Bunds and 21y Bunds totalling €2bn. The US will auction 2y FRN totalling $28bn and a new 5y note totalling $70bn.