Eurozone optimism has pushed the German two-year yield to the brink of pre-'Liberation Day' levels. Just shy of 2%, the balance of risk is towards near-term lower yields again. US rates are quick to fade the dovish move from last Friday, and we think the back end of the curve will want to test higher still.

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The German 2y yield is just shy of 2% again, but we see very little room for front end yields to rise further

Markets are cooling further on the idea of another European Central Bank rate cut. At points starting this week, markets were discounting less than 15bp of additional easing over the next year. More strikingly, and looking slightly further ahead, the 1y1y forward ESTR OIS is less than 4bp below current ESTR fixings. The optimism seems to come on the back of trade agreements being reached with the US, plus the prospects of sizeable fiscal stimulus set to come out of Germany. This has biased the PMIs and, more recently, the German Ifo business outlook higher.

These developments have pushed 2y German bond yields within shouting distance of 2% and pre-‘Liberation Day’ ranges again. We struggle to find good reasons for rates to push beyond this level. For all the optimism, we think markets are overlooking the downside risks – be it disinflationary spillovers as the Federal Reserve starts cutting or implementation risks around German spending and reform plans.

French headlines on Monday afternoon highlighted that other sources of potential turmoil could dent the optimism. The French Prime Minister has called for a vote of confidence over his government’s savings plans to take place on 8 September; this will force opposition parties to take a position ahead of planned street protests. The spread of 10y French government bonds over German Bunds ended at 5bp. In the Bunds themselves, it was enough to trigger a small safety bid as 10y Bunds richened 1bp versus swaps, while the 2y is still around 0.5bp.

Looking further out, we do think there are reasons to be more bearish on rates, and we should be looking for a steepening of curves from the long end first.

Back end of US curve not tamed by Powell, and rightly so

The dovish turn of US rates after Fed Chair Jerome Powell's speech on Friday already seems to be showing signs of fading. While markets are still holding on to two more cuts this year, the belly and the back end of the UST curve want to test higher. And we argue this is indeed the sensible reaction. Earlier cuts leave the back end exposed to inflation risks, which will only intensify in the coming months. Add US President Donald Trump’s challenges to the central bank’s independence (including the latest moves to fire governor Lisa Cook) and fiscal deficit concerns, and together those give us the ingredients to reiterate our bearish view on 10Y USTs in the near term.

Tuesday’s events and market views

Most data of interest will come from the US. First, we have durable goods orders, where the headline number is expected to decline by 4%. Having said that, the headline series is very volatile, and consensus sees the number excluding transportation (i.e., Boeing) rising by 0.2%. Then we have the FHFA house price index for June, which may also get some attention, given that weaknesses in the housing markets are starting to show up. The Conference Board consumer confidence index is expected to nudge lower from 97.2 to 96.4.

In terms of issuance, Austria has a syndication scheduled for 7Y RAGBs for an estimated €3bn. From Italy, we have a 2Y BTP auction totalling €3bn, and the US will also auction 2Y Notes for $69bn. Until the end of this week, Belgium will issue 1Y and 10Y retail bonds.

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