Global Rates: European Rate Markets – looking ahead over 2H26

Hi and welcome to @Nurate, JAPE Morgan's global research podcast, where we take a look at some of the driers behind the biggest trends in themes across 16 Kim Curransees and Kim Multimarkets. I'm Francis Diamond, head of European Rates Rastery at JAPE Morgan, and today I'm joined by my colleagues, King Andrew Gupta and Edithie Toria to discuss our thoughts on European rate markets over the second half of this year. So to state the obvious, the Middle East conflict has dominated European rate markets over the past few months, and I think going forward, we still expect this to be one of the main drivers as we look ahead into the second half. Latest news reports of MOU on the deal between Iran and US may be have given a little bit optimism to markets, but I think in our sense, the medium term outlook for Middle East conflict still remains uncertain. And despite the recent fall in Brent oil prices, there is still an indirect impact of energy shock that will persist and impact both UK and European inflation dynamics over the coming months. If we look at market performance this year, front end rate, so 1 you 1 you're son, you're 1 you 1 you're 1 you're S.T. yields are 75 basis points and 45 base points higher respectively. As markets continue to expect some degree of monetary policy tightening. So let's start with the ECB again, Dr. Who have heights, or say 25 base points this week as expected and presented baseline energy scenarios that imply a total of four hikes given more elevated and sticky core inflation projections. So how did you read delivery? What do you think of current market pricing and has the ECB dampened rate market volatility for now? Thanks Francis. Now, if the ECB's goal at the press conference was to keep market pricing largely stable, then President card was triumphant in that regard. Asisterials remain broadly unchanged during the conference, whereas volatility to like point to point the basis point. Now of course, yield rallied on towards end of the day, but that was due to their positive headlines around Middle East and not on ECB. So the delivery was largely consistent with recent ones where volatility remains muted as the ECB speaks to its data dependent meeting by meeting approach. As I mentioned, post-apositive headlines around the Middle East yields rallied a lot and as the curve is now pricing around, give or take seven basis point for June, 24 basis point for set and 38 basis point of hikes for the December meetings. And with the peak of the extra per pricing around 43 basis point of further hike from the ECB. I think this levels are broadly fair and believe that ECB pricing will remain in relatively modest ranges. The ECB didn't appear in my view to be concerned too far behind the curve and thus we believe that future hikes will likely be measured and well telegraphed. In my view, I think the tail risk of significantly higher rates are shrunk or we should cap volatility as well. Okay, so front end looks broadly fair. I mean, a detour if we go further out the curve. You've been highlighting this range trading environment, potential buns based on a various Middle East conflict scenarios. Does anything there change over the next couple of months? And if you look cross market, do you see any opportunities? Sure, Francis. So the title of my piece is a range bound. So I think we will, my expectation is that when the yields are mostly the euro yields will remain stuck in tight ranges, but overall, over the two, the second how about 2026, I retain our strategic bullish duration bias, both on the 10th Germany, both outright and cross market versus US. But also it's driven under combination of several factors. Like one, the ongoing uncertainty around the US Iran conflict and the status of the state of her moves is likely to keep macro and policy out to volatile and the rest of the country and clear and that would be driving the range. The bunials within those ranges and on the ECB, like after the yesterday's meeting, we are going to still believe they will deliver one more hike in September of 25 basis point, but given the hawkish focus they presented, I think now the risk you has moved more than delivering more of chance over three hikes instead of stopping at one. So two still remains a strong base case, but with a risk of three and the market pricing is almost there. So not a big market move over there. ongoing strong investor demand for EGB mainly coming from down to our 6th, we published our global activity out of activity chart back today. And if you look at the data from the first quarter, the demand for euro guvies was quite strong coming from international investors and also some domestic investors like banks. And I think that is pushing on term premium not being a euro narrative. We have been running for a while. And then lastly, the fiscal response to question against rising energy prices will likely be limited, which has been the case so far. So given all these factors, I still believe 10 years German yields will remain range bound. And when we do our Middle East conflicts scenario analysis, we found that 10 years German yields should be moving somewhere between 285 to 315 range in majority of scenarios. And over the near term, what we have been doing and we continue to prefer doing the same like range trading that range tactically. But at the same time, what we have been stressing. And I think that remains my high-conditioned view is that intermediate yields on the German curve are pretty much across the EGB spectrum are quite compelling for long-term investors who can tolerate the near term volatility of these range moves. Like what we have been saying is 10 years when yields trading around 3% is quite attractive. As the risk of a large sustain cell of about 3% is quite limited, even in extreme scenarios. Given our view, as I mentioned above, that fiscal term premium is not a German or a euro story. And also, if let's say there is a material repricing higher of ECB tightening expectations if we move pricing closer to more than 3% cumulative, in that I would expect a bit more bear-flatting of money market curves, which will again keep intermediate level of yields much more anchored and range bound. So overall, I think locking 1.3% is a good medium term stance in our view. And finally, as you also highlighted, like cross market, we have a strategic over German versus US bias, especially in the intermediate sectors given our bullish duration stance on Europe. The valuations are also attractive on when it's just seen from any market pricing between US and Europe. And finally, even our US colleagues have shifted to a more bearish view on US duration in recent weeks. So all these add up to a strategic over Germany versus US bias. Okay, so that's pretty clear. I mean, if we then focus on interim use spreads, I mean, that's tied in the ranges, I'm pretty sticky at these sorts of levels. You think this dynamic continues over the next few months or do you think there's any potential for idiosyncratic widening as 2027 elections in some of the bigger countries start to come onto the radar? Yeah, so on interim in the US SS spreads, like our strategy has been quite unchanged. For pretty much even before the Middle East, geopolitical escalations we have seen since March. And that has been that the risk reward is not attractive in spreads at current levels. And we continue to retain as cautious stance given the heightened uncertainty around Middle East and the state of almost valuations as I mentioned are not cheap. The carry is quite limited. And also the positioning is still over it. So all these factors doesn't give me much excitement about only carry in the space. What we are highlighting in our major outlook is that we plan to trade spreads tactically after the summer because we believe that the focus will shift towards a presidential election, news flow and polling. And in my base case, I would expect any from some of the trade between 70 to 85 basis point range. We are currently around 75 basis points. So I think the bias will be trade from the lower end of the range to be short. And similarly, we plan to trade the talent spread tactically around potential political noise linked to 2027 budget negotiations because I can see some coalition friction happening given that the recovery fund is ending at the end of 2026 and also they have to do some more higher defense spending. So budget negotiation could create some noise. And in that world also I can see technically Germany spread trading in a 10 to 15 basis point range on those noises. So again trying to capture that tactically would be one of the strategies we would be aiming in the second half of next year. And lastly, if I have to pick some of my favorite overt picks, I would say Spain and Greece and entire MU and EU and SSS base are my favorite picks. Let me jump in here and then maybe switch into the focus to Francis. So Francis, you know the Bank of England meets next week and market expectations are formally for them to keep rates on hold. How do you see that tone evolving around the policy stance and in terms of Daniels, what's the view for the second half of this year? Yeah. So as you say, there's very little price for next week meetings on the 18th of June and we fully expect the Bank of England will keep rates on hold at 375. But I do think there will be some dissent. So we have a 72 vote split with probably NPC members pilling green dissenting for a rate hike particularly given some of the commentary from both of them around the impact of supply shocks and the impact on inflation expectations and wage formation processes. Possibly we may see a third hawkish descent, maybe Rams, Norman, also voting for a hike but there's not been a huge amount of commentary from either of those two members recently. So I think the tone will kind of give you a sense that there is sort of hawkish bias. I don't think NPC in general messaging will push back much. on the market pricing where we've got about 40 basic points of price by the end of this year, but I also at the same time I don't think there will be much visibility in terms of the timing of any potential rate moves. So I think given where we are in terms of market pricing, I think there's a limited ability for the BUE to really give a hugely dubbish message here, even if there is some evolution or sort of potential change in the Middle East outlook, purely because indirect effects will linger, and even if some MOU is agreed in the coming days, the impact of the increased energy prices that we've seen already indirect effects on consumers will persist and probably some of the market optimism in terms of the recent rally we've seen in front of yields in the last day or so on the longer term solution to the conflict looks a bit overdone. So our base case is for a 25 base point hike in July. As we go further out the curve, I think it's similar to how we discuss with the DC of the View on Buns, to be honest, I think 10-year-gilt yields are still very much range bound, bounded by our Middle East scenarios. We have nudged our end of year for Q26 yield forecast, the 10-year-gilt a little bit higher to sort of round about 480, so only a few base points below where we are now. And we wane roughly sort of neutral in terms of a market views here given yields are somewhat 10 base points below our ongoing straight-up homies limbo scenario for the conflict and still some 35 base points below our high-end energy shocks on our abjections. Okay, I guess the other point is that domestic politics remains in focus as the makers field by election approaches against the backdrop of two ministerial and regional resignations this week. So how do you think political terms can impact the curve and the subscripts? Yeah, so the election is growing closer. It's the same day as a bank of England. And yeah, I think there is just increased pressure again on Prime Minister Starmur, as we saw a resignation of first a defence sectorary John Healey this week and then few hours later one of the junior defence ministers also resigned. So I think this does mean focus on the by-election and the subsequent sort of bill over effects in terms of a a labor leadership contest. It's still very much there. As we highlight in the last publication, when you look at the opinion polls, it's only been two at the time of recording, still show a pretty decent lead for burning my head over a form. And there's also a sense when you look at the sort of parliamentary voting intention of voters in in maker field that sort of burn them as a labor candidate kind of gives a general 15% boost for labor if you were to kind of roll forward those those opinion polls into an overall parliamentary vote. So if you assume Burnham wins a election, I think it's more reasonable to expect there'll be some form of labor leadership challenge launched in subsequent weeks and possibly the larger the margin of victory made for talking about sort of a winner that's same more than 5,000 voters sort of majority above reform. Then possibly the senior will see an announcement from Burnham on his leadership challenge. I think given we have seen just more pressure with these resignations you mentioned this week, it is also possible that even though Starrmer has said he would fight any potential leadership contest, possibly he could just concede very quickly if Burnham is the early challenger. But I do think if if other challenges appear alongside Burnham, then probably a leadership contest is going to take a whirl through you at the summer and possibly late summer early autumn before we get any clarity around the result. Although in terms of markets, I mean, I think probably if Burnham wins, that the very limited guilt market reaction. And I think if you were to see any let's say knee jerk steeply in the curve post the bi election, I think in our sense, I view that's probably a bit of a fade. Given I just don't think we're in any position this day as to consider disclinitations of a Burnham winning the bi election without getting closer to a budget later this year, I don't think we can really draw much conclusions around how fiscal policy could evolve. I didn't even, if there were one of the surprise reform victory, possibly we see a little bit of flattening of the 2010s, guilt curve. I think going forward does you look through the second half of this year, if you do have Burnham as Prime Minister at some point following a potential leadership contest, then I do think at some stage, maybe the focus might need to shift in terms of the fiscal outlook in his kind of potential government in terms of possibly increased investment spending, try to shift the focus a bit more in terms of a more positive growth narrative. I think our sense as we get closer to a budget in the autumn, maybe that's September, maybe that's October, difficult to know at this stage, I would expect there to be some increased risk premium priced into both the sterling curve, so probably a steeper 210s guilt curve and narrower 10 years walk spreads. However, I think for now it's just too early to position for this given we are continuing to see the ongoing as a market impacts of Middle East conflict and the evolving sort of potential for deal or some form of resolution, it's still the main driver of UK curve at this stage. So, again, let's end with a few thoughts on scandidae rate markets. So, for Sweden and Norway, how do you see central banks acting over the rest of this year and a market's priced in line with the EU views? I think both next time can not just bang will stay on hold next week, but we do see them hiking in September in our baseline scenario. We expect both of them to deliver just 125 basis and 5, but acknowledge that it is advised towards maybe more hikes after that. I highlight that currently, core inflation in Sweden is low up to around, so CPI 8 is around 0.5%, but that includes a 0.9% impact of the 80 cut that was put into effect on from April 1st. Headland inflation is already at 1.5%. So, accounting for the VAT adjustment is above the 2% target with risk of this rising over the coming months. I think the next bank will likely deliver a hawkish message next week, taking up a hike over the next few months. On this, I also mentioned that East AECV 8 hike this week and integration to hike further will also play a role in the expansion of action. So, yes, one hike in baseline with potential for more over the rest of the year or early next year. The not just bank will find it hard to not deliver a hawkish message in my view, even though this day on hold after delivering the surprise hike last month. The underlying inflation backdrop in Norway remains strong with core around 3.4% in May and expected to hover around 3% over the coming months. I expect them to also raise their guidance for neutral rates higher next week with upper end lifted towards the 4% mark from currently at the 3.5% mark. This is nominal rates. Now, I think they should lead to some steepening of the money market curve in the second half of 2027 and beyond that sector should steep in based on their rising of neutral rates. On market pricing, I believe they are broadly fair against our baseline, but like as I mentioned, I do see risk of some underperformance versus a rival over coming months mainly because the amount of hawkishness I expect from these central banks under displays is probably just about fair in my view. Okay, thank you for that. Kegendria, thank you, Dita as well. That's all from us. Thank you for listening and stay tuned for more updates on fixed income space here on @anyrate. JPMorgan's global research podcast series. This communication is provided for information purposes only. Please read JPMorgan research reports related to its content or information including important disclosures. Copyright 2026, JPMorgan Chase and Co. All Rights Reserve. This episode was recorded on 12 June 2026.