A hawkish ECB press conference helped our bearish case on 10Y swap rates, but markets will face resistance from the bullish momentum in the US. The US 10yr 4% level was breached twice, albeit briefly, on Thursday. It seems to be setting itself up for a breakbelow. All it needs now is a solid excuse. Something like the buildup to a first rate cut in a year – maybe.

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Thursday's market moves suggest euro rates can disentangle from the US

We rarely see US and euro rates diverge as much as on Thursday, but the bullish move from the US won eventually. Nevertheless we see two very different rates markets, and thus seeing more days with diverging moves is likely. The Fed has many more cuts imminent, whereas the European Central Bank is in a holding pattern. At the same time the growth outlook for the eurozone is one of recovery, while jobs market woes dominate the US narrative. We still think the 10Y euro swap rate can drift higher over the near term and diverging moves like we saw today show that EUR rates may even manage this in a UST bull market. Especially if the eurozone growth recovery keeps up, the 10Y swap rate could start eyeing 2.8%.

Having said that, the 10Y EUR rate may not continue drifting higher if a further deterioration in US data starts hurting global risk sentiment. But with the S&P 500 hitting new records in response to Thursday’s disappointing US data, that doesn’t seem to be the case for now. Another risk is a further escalation of the French political turmoil, yet even then the spillovers beyond French government bond yields have so far been contained.

With a view to the EUR front end our economists no longer view a rate cut as the central scenario for the ECB. Nonetheless, the ECB has not fully closed the door to further easing. The market has reduced its prospects for another cut with the easing priced by mid next year pared back to 12.5bp, making it basically a coin toss. The 2y Schatz yield briefly hit the 2% level. As we have stated before, at a level close to 2% we see on balance more reasons for rates to go lower than higher in the coming months.

France faces its first rating test following the latest political upheaval

Rating agency Fitch is scheduled to review France on Friday and any updated will be published after markets close. The risk is obviously for a downgrade as the agency cites "failure to implement a credible medium-term fiscal consolidation plan [..] " as the rationale for a potential downgrade. A downgrade would also show some consistency with the recent lowering of Belgium's rating to A+/Stable in June.

That said, there are also arguments to sit out a politically sensitive decision. Fitch did already say in March that they anticipate new elections in the second half of this year, so we are seeing their assumed base line scenario unfolding.

Also the 2026 consensus GDP growth forecast for France is now in line with Fitch's 0.9%. The consensus had been lower, but has inched up again since bottoming before summer. Fitch itself had lowered French growth prospects in March "mainly due to the risks of rising international protectionism and weaker growth in Germany, France's largest trading partner”. While it said “the impact is somewhat mitigated by increased European defence spending […]", it crucially made no mention yet of Germany's fiscal U-turn where first intentions became public early March, only shortly before the French review.

A downgrade would probably not change the broader picture for French bond markets since a 10y spread of 79bp over Bunds, nearly on par with Italy, already reflects expectations of rating downgrades over the medium term.

US Treasuries maintain a positive gloss on a growing sense of concern on the economy

In the US, the 10yr yield finally decided to make that break for 4%, and scraped through to get below, briefly. Now back above, just about. Not a convincing break, but its been hit and breached, so next time it can get through with some more conviction, when provided with the excuse to do so. The excuse Thursday was in fact not quite as convincing as the excuses offered Wednesday (PPI) and Tuesday (employment revisions). The CPI inflation data released Thursday were if anything a tad firmer than expected, especially the headline 0.4% month-on-month rise, and we’re left with core inflation still running at 3.1%. Jobless claims rose, but continuing claims fell. Bond positive yes, but not glaringly so. The fall in real weekly earnings to 0.4% year-on-year is something to ponder though. That in itself is absolutely not great. Of the data, that’s the one that should worry us the most (and cheer the strange bond beasts that love macro pain). The 30yr auction later in the day was absolutely fine, and in fact solid given the firm market that it was auctioned into. A firm market helps from a sentiment perspective, but can risk a tail, which we never got, so all good.

Friday's events and market view

In terms of data we have the final CPI numbers for France and Spain, but usually these don’t pose any surprises. Also from the eurozone we have the ECB’s Governing Council members Rehn and Kocher talking about monetary policy, possibly of interest after Thursday’s meeting. The US will publish the University of Michigan sentiment index, of which consensus sees the headline figure broadly stable at 58.0.

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