Yield outlook: Optimism has become excessive

Long-end rates continued to zigzag through July within the same ranges they have operated in since spring. Recently, the market has significantly increased its expectations on rate cuts over the next year, but neither the ECB nor the Federal Reserve (Fed) appears ready to compromise on flexibility. All decisions at upcoming meetings are "open" and "datadependent," which in practice means that the central banks are refraining from signalling when and how quickly the cuts will come. Therefore, we remain in a phase where fluctuations in key data (inflation/growth) can cause quite significant market volatility.

In Europe, soft growth figures for June/July have fuelled hopes that another ECB rate cut is on the table for September. The 10-year German government bond yield has dropped 25 basis points (bp) over the last month, while the market now discounts additional rate cuts worth 55bp by year-end. However, concerns about domestic inflation dynamics have not disappeared at the ECB, and several important data releases (i.e. wages/productivity) are set to be released prior to the meeting, which could encourage a more cautious easing cycle. Our main view since spring has been that the next ECB rate cut would be in December, but this summer's growth figures have increased the likelihood of a September cut.

The bar for a significant drop in long-end US rates has been raised In the US, indications strongly suggest that the first rate cut will occur soon Inflation data has been weak for several months, and the labour market continues to balance better; the labour shortage has softened, job postings are lower, and wage growth has moderated. Additionally, there has been a shift in focus among Fed members, who increasingly highlight the risk of easing too late. We expect to see quarterly cuts of 25bp at the meetings in September, December, and into 2025. We expect the policy rate to be 100bp lower in 12M relative to today. However, after the recent correction in expectations, markets have already priced in a total of 140bp, thus setting a high bar for the Fed.

We expect slightly higher long-term interest rates over the next 12 months We expect that long-end rates will continue to fluctuate around summer levels in the coming period. The direction of inflation and growth data should be the most decisive factor, and here we see a continued mixed development for the Euro Area. This should encourage the ECB to continue exercising caution in easing monetary policy. Short-end rates will gradually decline as rate cuts are implemented, but at the long end of the curve (10 years+), we see a largely unchanged rate level 12 months from now relative to today.

However, the flat development in long-end rates that we see unfolding over the next year will certainly not be without bumps along the way. In addition to monetary policy signals and economic data, market focus will also be on political developments in the US, where the presidential election is now just three months away.

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