Rates are back under upward pressure, reviving our tactical bearish view. AI risks have become more idiosyncratic, but upcoming catalysts could quickly reverse the move. France remains under pressure, while Italy could see a rating upgrade
Tactically bearish on rates but AI event risk ahead of us
Price action suggests global rates are happy to push higher again, and we therefore return to our tactical bearish call. Risk sentiment is improving, with AI worries turning more idiosyncratic, focused mostly on NVIDIA’s (NVDA) leadership questions. Amid more stable risk conditions, but without strong catalysts, the 2yr USD swap jumped up by some 12bp on the day. Of course, one could argue oil ticked higher and jobless numbers were robust, but nothing that would warrant such a strong reaction by itself.
Buying the dip seems to be the recurring theme in equity markets, but we warn of some key event risks ahead. Next week, we have both Anthropic’s IPO pricing and NVIDIA announcing third-quarter results. These two events are seen as important bellwethers for the broader future of AI and can also shake the US macro outlook. From the past weeks, we’ve seen how any disappointments can quickly push US rates lower.
Europe is relatively more shielded from AI, but global risk sentiment can be quick to pull down longer rates in particular. We argue that the front end of the EUR and GBP curves should remain focused on inflation, but the belly of the curve is more exposed to sentiment. The euro swap curve still paints a very optimistic view of the ECB’s terminal rate above 3%, which in our eyes can only hold if the growth outlook improves materially. A global setback in AI would push against this narrative, raising expectations for rate cuts after the initial hiking cycle.
EGBs drift with the broader sentiment while Italy is up for review by S&P
The mood in the European bond market has again darkened somewhat. In part, this owed to the spillover from tech-related equity jitters and unease around geopolitics after the latest comments from US President Donald Trump, but the general repricing higher of rates, which originated in the US, has done its share as well.
France has lagged its peers with the 10y OAT/Bund back towards 150bp. There has been little news on the situation in France, but it is worth noting that any hopes of ECB President Christine Lagarde pulling France out of its political deadlock were dampened after the first polls this week showed she would get only 14% of the first-round votes, similar to other centrist candidates. This would still see election frontrunner Marine Le Pen and left-wing rival Jean-Luc Mélenchon advance to the second round, leaving one of the tail risk scenarios on the table.
Italy, meanwhile, will face a scheduled review date by S&P, which currently rates Italy BBB+ with a positive outlook. That outlook has been in place since January, which would make a first rating upgrade back to single-A a possibility. Considering the more uncertain political and fiscal outlook recently, a postponement would not come as a surprise.
Friday's events and market view
The European session will see a busy slate of ECB speakers, including Isabel Schnabel. Data comes in the form of final October inflation readings for France and Spain, as well as the second reading for Q3 eurozone GDP growth. The US will watch the October PPIs and a continued busy slate of Fed speakers, including Susan Collins, Lorie Logan and Michelle Bowman. After markets close, eyes will turn to the scheduled rating reviews. The main focus is Italy, rated BBB+/Positive by S&P. Fitch has slated a possible review of Germany (AAA/Stable), and DBRS has slated Portugal (AH/Positive) and the UK (AA/Stable).
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