Global Rates: Dissecting the sell-off in European rates, next week’s BoE meeting

Hi, and welcome to @NUrate, Dave Morgan's global research podcast, where we take a look at some of the drivers behind the biggest trends in themes of fixed income currencies and commodity markets. I'm Frances Diamond, head of European Rate Strategy at Dave Morgan. It's a day I enjoyed my colleague, Dieter Chordier, and again, Dr. Gupta, to discuss the recent sell-off on European rates this week, books will cease the switch risk, and next week's BLE rate meeting. So this week, these will be delivered at 25 base point rate hike, with frontend now pricing another roughly 80 base points of hikes over the next 12 months. And similarly, the Sonya frontend curve prices round about 100 bases points of hikes over the same period from the BLE. And this week we'll see 10-year buns reach multi-year highs at 3.5% and 10-year gilts close to 5.3%. So it is yet, this sell-off in European rates we've seen this week has been pretty sizable. If you look at the frontend 1-1-year ester is at 3.25, is all this about just the rise in oil and gas prices, or did the speed delivery this week also drive some of the move in front end rates? Thanks, Frances. So yeah, like the frontend, let's, if you start from there, like the money market as the ester was already selling off, we're going to the ECV with a little more weeks. And primary driver has been in our view the Middle East conflict, because of the escalation then the prices have significantly increased. And I think on top of that, there has been a lot of anecdotal evidence that there has been an ongoing wave of pushing wash outs where investors who might have been receiving at the very frontend have been stopping out because of the sharpness of the moves. So I think that also added to the large moves on the large sale of your scene at the very frontend. And then the ECB indeed, the projections on the inflation side were all kish versus the market expectations. So it did add to the sale of momentum. It has come down a bit today, but overall, I think it was mainly the Middle East led energy price moves, a combination of position wash out and then ECB adding a bit to the hawkishness. Or thinking about the violations and everything. So our economies have another 25 years this month of hike from ECB in December, but they are clearly flagging that even the recent enterprise moves and the ECB projections, the risk is that could be another 25 basis point in March next year, so accumulative of 50. But clearly, as we mentioned, market is pricing accumulative of around 75 to 80 basis points. So our terminal 325 is clearly looks much higher or stretched compared to our projections. But we still believe that given the limited visibility over energy prices, it's very hard to be actively pushing back on a current market pricing. Okay, so further out, there's been a lot of focus on the rise in 10 year and long yield that's globally. So do you think global dynamics are explaining why 10 year buns are 3.5% or are there idiosyncratic European drivers that can also explain this? So I think the intermediate part goes, has been a combination of stories and that's why like the move there is not something which we were expecting, let's say a couple of weeks back. So what we have, as you mentioned, like the bunnies have made new highs, we had 350. I think the last time we saw was more like 2011. And when I look at the underlying drivers, even this week, it was the same drivers which has been driving it over the past couple of weeks. So it's partly driven by the repressing higher off ECV terminal rate on rising energy prices. The one we discussed above. But also, it hasn't partly driven by the limited bear flattening move in the money market curve because typically you expect in a large front and repricing, the money market goes 10 to bear flattened, but this is around what happens on the margin over the past few weeks, the money market curve have not flattened on the margin at times they have even steepened. And I think that's what's mostly driving the intermediate yields higher. And that's something that I said before, we were not anticipating. And I believe that the combination of factors could be behind the lack of this bear flattening on the money market goes first being higher neutral rate expectations. That's a narrative which has been going around, but something which might have been, which given the recent economic resilience and also the broader AI driven productivity gains narrative. I think it has got a bit more tension. Still elevated wheat out of the US rates of global rights have sold off in the intermediate part of the curve for different reasons compared to Europe. But those have pushed euro yields higher given the wheat has still remained elevated. CTA activity like when we look at some of the signal moment of signals which we produce in our team also like we are seeing the signals pointing to Max short. So also negative evidence is point towards an ongoing selling activity by CTA or the summer period when the moment cell phone was getting momentum and lastly, position technicals. Any road to evidence against suggest as I mentioned above also ongoing wash out or receive positioning in money market forwards. And that also for the added to the intermediate cell of interview. All these things again, as I said, it's partly different than part of the lack of flattening on money market curve. But interestingly, this time around, fiscal concerns were not behind the cello. And that was clearly evident by the German software's moving sideways. And then when we decompose some of our relation frameworks, we didn't see any fiscal company that repricing. That was quite interesting. So now thinking about like now we have decomposed a move. So how do we think about the different drivers? As I mentioned, front end repricing, we find a current ECB-1 pricing on the cheap side. But given uncertainty about the middle east situation and also the price, energy price, volatility, it's very hard to actively push back on it, despite it being on the cheap side. On the terminal repricing or the higher R star on a neutral rate, our economists are arguing that maybe the Euro area, given the growth of silence, a neutral rate might have moved from let's say two to quarter to two and a quarter to one half percent. So maybe a 25 basis one move higher, but that doesn't explain market pricing. ECB policy rate at 3% over the next few years, because a terminal rate closer to 3% still looks a bit of a stretch in our view. On the beta to US, yes, we had had a very strong beta recently, but our view still remains that the beta of intermediate-euro rates to US should decline going forward, especially in scenarios where the US sell off is driven by monetary or fiscal policy concerns, which are not necessarily the same concerns, which are, let's say, our concerns for the Euro area market. So the beta should decline, but I think that given the broad technical setup, the beta remain elevated. So we believe that all these things has pushed, you know, into my eels higher than what we would have expected, and they appear cheap. And given sort of the uncertainty about the CDA positioning, US beta, and lastly about energy prices, it's very hard to practically pay these recent cheapness. We therefore don't recommend an active tactical over the duration positioning, but at the same time, we maintain our high-conviction stance that Germany, German rates in intermediate sector are quite cheap for investors who can withstand medium-term or near-term volatility. At the same time, we also maintain a high-conviction stance that German rates should outperform US, especially the intermediate part of the core. OK, so that's a pretty comprehensive summary there. So if we think just about intramus spreads and the widening we've seen this week, is this just a risk of move then? Yeah, like intramus spreads, I think, providing was pretty much on this heightened, heightened CO-political uncertainty, the increased DM rates validity, which again added to that uncertainty, and also the hawk issue of delivery. So all these things combined, I think, had put some pressure, and on top of it, similar to the other parts of the markets, I think personally, technicals also played a role because anecdotal evidence pointed to worst liquidation of some overt-carry positioning over the recent weeks. So all these things on average added to the widening we've seen, so the high beta names. And this has been in line with our thinking that we have been holding a very cautious stance on intramus spreads. And even after the recent widening, we still believe that the carry or the current level of spreads is not providing enough cushion against any potential risk of widening risk, especially given that the positioning is still not clean yet. We still believe the positioning is on the O which side. And we also highlighted in a publication that the sensitivity of intramus spreads to the level of ease has picked up over recent peaks, which has further reinforced our cautious stance. So after the recent widening, intramus spreads, especially in the French and Italian spreads, are now screening wide on our fair value frameworks, and also cross-market versus Euro-area credit markets. But however, we believed that the stabilization in global rates and also energy prices uncertainty to decline a bit from here in order for market to refocus on carry exposure and for these excessive cheapness to fully correct. So I think it will take a while. I think we might remain in a bit more volatile choppy markets, which is not great environment for carry trading. Okay. So, again, I guess one side effect of this recent rise in yields is that the books will future see the switch risk of now increased. So how do you see this evolving? And do you think there's any basis trades out there that look attractive in that part of the curve? Hi, Francis. Yes. You know, the recent sell-off has increased the risk of current CDD. That is the DBR August 54, switching to the DBR August 52. Now, we estimate that the CDD will switch if 30-year yields sell off another, let's say 20 basis wind or if the 52-54 curve flat ends by another 4.3 basis point and with the eels spread wall of 5254 around 3 basis point that's not really a very low probability event. I think in our models given that the volatility has increased recently for yield and also for the curve, we ascribe about 25% probability of such a switch. Fundamentally speaking, the switch has increased only in bucksell features whereas other urex features still have the CTTs to be dominant irrespective of yields rising across the curve. I think this is because the notional coupon for bucksell is at 4%, whereas for other futures it is still sitting at 6%. So in that sense with 30 year yield hovering around let's say currently around 390 other bonds in the basket start to compete for the CTT status. Now I also see that what is more interesting is that the CTTs switch from 54 to 52 will be associated with around 35% change in futures delta. So it is large for investors who don't dynamically hedge their futures position. This is a large risk to manage and therefore it's a bit concerning for investors to watch out for these things. We also ask about the CTT net basis currently is around 33 cents and we estimate the delivery option value to be around 22 cents that leaves the pure misprison component to be at 10 cents, meaning that even after adjusting for the delivery option value features currently appear 10 cents to cheap relative to a fair value models. While these numbers this level of misprison may make a short basis positions attractive, I should stress that a short position currently essentially long duration proxy and therefore I am very cautious on such rates, especially in the uncertain markets. One of the there was mentioning earlier about about German yields behaving going forward uncertainty around them. So the France is let's shift the focus a little bit to the UK. The front end of the UK curve prices just over 100 basis point of rate high size you were mentioning earlier in the next 12 months or so. Now given energy prices and the ECB delivery this week do you think the Bank of England will hike at the September meeting next week? Well, I think certainly is going to be a lot of focus and obviously we have the feds the day before which is now close to 20 basis points of high price, but I think ultimately the answer is no. I'm not expecting the BUE to hike next week September meeting. I think they keep rates and hold at 3.75%. Probably we still see decent the 3% you saw at the prior meeting. So a six three votes split or that maybe you could see a lot more early join the other dissenters so green man and pill in dissenting for rate high. I think ultimately the focus on the energy price moves is there and clearly there's been a reprice the front end as we've discussed. But I think so far the commentary from the BUE is probably still not quite at the point of delivering a rate hike here. Probably you would expect the language in the minutes to reflect some of the the recent indirect effects on inflation from the recent energy spike becoming a larger risk of inflation. Obviously, it's been more resilient in the growth data and actually when you look at the NPC commentary at the Treasury Select Committee this week. I mean, it wasn't really a sense that the rhetoric or the view was materially changing, but we did hear a tacit acknowledgement from Governor Bailey that inflation risks are to the upside. Which might come across in his statement paragraph in September meeting minutes. So I think as well when you kind of take that into consideration, plus the fact that the market pricing is round about sort of six to seven base points of rate high expectations for September meeting. I don't think the bank of England will want to surprise, although it is fair to note that market pricing has gone up a little bit given the energy moves to be seen this week. And also the the to be delivery. So I think ultimately they skip next week September meeting and deliver a 25 base point hike for November. I mean, yes, you mentioned there the the rate pricing further out of the front end of the curve. I mean, yes, we've seen a very big sell off this week. It reflects the same drives the duty mentioned in terms of the spike hiring in gas prices, the up moving Brent to over $100. It's really around the Middle East tensions and growing risks and more patractic conflicts. And yes, I think you can argue a rise in energy prices does increase the risk of a larger indirect effects on inflation. But so far you don't see clear evidence of second round wage pressures coming through from these inflation channels. And there is obviously in the UK the ratchet effect that takes bit of time domestic utility prices and electricity prices to a juft upward based on the off gem price cap. So I think it does look a little bit excessive the over 100 base points of high price over the next 12 months. But similar to what I did to mention what you mentioned as well, I mean, given the high pulse to beat to energy prices, particularly once we get past the first couple of months of the OIS curve. And the limited visibility just in terms of where oil and gas go, I think it's difficult to be really solid in terms of fading these at the moment. Okay, you know, if I go a little bit further out the curve, 10 years, and now close to the multi your highs at like 5.3% and 30 years, is now close to 6%. October budget is approaching. So do you think some of these valuations represent increased fiscal risk premium? I don't really think so. No, I mean, I think a lot of this is is a global factors. We've been discussed in the intermediate section of the curve that's been weighing on on 10 year and 30 years and the energy driven sell off at the front end. There's just led to this broad repricing of central bank, not just the BLE, but the ECB has seen this week and US rate high expectations, rather than idiosyncratic UK political or particularly fiscal risk factor into the budget. And I think I point out that yes, optically these are very elevated levels as you say, but actually 10 year yield look pretty close to fair value once we adjust 10 year yields for the level of front and rate. So 1 year, 1 year, Sonya 10 year dollar. So US treasury rates and adjusting for some sort of bank of England APF, let's say factor. I mean, yes, there is increased focus on the fiscal dynamics. As you mentioned, the budget is growing closer. I mean, last weekend, chance of a healy delivered a speech, suggesting the budget will probably be one that's a bit more cautious will exercise degree of fiscal discipline. And I think that is probably reflecting the fact that borrowing costs have risen. So I think if that is a message to sort of take here and this sort of message continuity around the UK's overall fiscal stance from where the last budget was under chance for the Reeves. I think it's probably likely we see more restrained and limited increases in taxation and spending. And I'm probably now less concerned that the budget will result or the run up in the budget will result in any significant increase in market pricing of UK idiosyncratic fiscal risk premium. So by that, I mean, steeper curve that's driven by UK idiosyncratic factors or, or narrow swap spreads. And if the budget is delivered in that sort of sense as we sort of have outlined here, then probably that's still leaving in place around about half percentage point of fiscal tightening. So not something that should really be concerning markets in terms of large amounts of fiscal easing at higher levels of yields. And again, if you look at the 2010s, guilt curve is a sort of a proxy for trying to isolate any fiscal risk drivers. It's bare flats in this week following other DM rate markets and reflecting the large sell off in the front ends of UK curve. And again, from a sort of relative standpoint, the curve is only screening a couple of basis points steep against front end yields and the shape of the US curve. So I think going forward from here, assuming there's no surprises or shifts in the rhetoric we sort of heard already from Chancellor Heli as we get close to the budget. I think really limited potential for any fiscal term premium steepening in the 2010s UK curve or cheapening and swap spreads. And I think these global dynamics and front end sort of repricing a central bank has expectations will continue to be the main driver of 10 years and 30 years. And so you honest, if you look at the 10s, 30s curve, despite the fact that yields have risen, it sort of trades in a very stable range and doesn't really look like it's massively out of line against the shape of other parts, such as the two tens curve. So thank you, Aditiya. Thank you, if you can, Kegendra, that's all from us. And thank you for listening, stay tuned for more updates on fixed income here on at any rate. For more information, please read Jake Morgan Research reports related to its contents, more information, including important disclosures. Copyright 2026, Jake Morgan, Chase & Co, all rights reserved. This episode was records on the 11th of September, 2026.