Rates spark: Lower despite the ECB’s hawkish holdouts

Rates markets remain in bullish mode, given a benign energy price backdrop, tech stock narratives to worry about, and even data with a whiff of macro weakness.

Treasury yields headed lower on a whiff of macro weakness

The US 10yr Treasury yield gapped lower on the back of Thursday’s data releases, which provided a whiff of macro weakness. The big outlier was the much weaker-than-expected 0.5% annualised consumer spending growth for the first quarter – a decline from 1.4%. GDP growth itself was actually revised up to 2.1% annualised, but mostly reflecting a downward revision of imports (which in fact gels with lower domestic demand).

The closely watched PCE inflation data came broadly as expected, even offering a silver lining with a better-than-expected 0.4% month-on-month headline reading for May. The year-over-year rate still came in at 4.1%, driven by an increase in energy-related prices. Firmness in housing costs and financial and insurance services nudged core PCE inflation to 3.4%. This latter number is the one that makes it tough for the Federal Reserve to cut, and in fact maintains the pressure to hike. We expect no change from the Fed for the rest of 2026.

Treasuries reacted to the consumer spending aspect within the first-quarter GDP data, dragging the real rate lower. Still, it likely is not enough to spark a follow-through rally given the offsetting firmness in the data beyond the first quarter; May personal income and spending were both up, and jobless claims data remained firm.

EUR rates brush away the ECB's hawkish holdouts

EUR rates have followed the US lead lower as front-end pricing of ECB hikes has also been pared back. Another hike by the European Central Bank by year-end is now just about fully discounted. Oil prices have shown only a muted reaction to news of ships in the Strait of Hormuz being fired at and to other setbacks in the Middle East. Levels below US$76/bbl still look relatively benign, and calls from the ECB’s hawks for further action are starting to ring hollow with market participants.

Isabel Schnabel, who is slated to speak again on Friday, had argued just this Wednesday that “as things stand, [the ECB] will have to raise interest rates further." Of course, there is still uncertainty around the ceasefire and eventual deal in the Middle East, and that is likely part of the reason officials remain reluctant to change their approach too quickly. Over time, a stabilisation could see the market price out these tail risks and also pare its hike expectations. Even our own view is that a year from now, ECB rates will be lower than what the market is currently expecting, but the near term still holds substantial risks.

A bigger round of Dutch pension transitions puts curve steepening back in play

More than €900bn of Dutch pension fund assets should transition in 2027, which could start making a mark on longer-dated rates in the coming months. The transition of €600bn assets in 2026 went remarkably well without triggering market turbulence. But reflecting on 2025's dynamics, we recognise that much of the market impact happened in the second half of the year. As such, we think that, going forward, the 10s30s curve may see some 10-20bp of additional upward pressure over the coming months.

To recap, Dutch pension funds are in the midst of massive reforms that broadly aim to transform the system from defined benefits to defined contributions. Under the new framework, pension funds have greater flexibility to tailor portfolios by age cohort. As a result, we anticipate less need for longer-dated receiver swaps of 30Y and beyond. The demand for shorter swaps is likely to stay high or increase. For younger participants, pension funds are likely to allocate more to equities, but for older participants, the demand for fixed income should be stronger.

Friday’s events and market view

In terms of data, markets will be looking at the ECB’s survey of consumer inflation expectations. The spike in three-year expectations to 3%, a level comparable to 2022, has raised concerns that this episode is ingrained in psychology. But with the last release, the survey has already nudged slightly lower to 2.9% and is expected to do so again. Dynamics pointing in the right direction could also ease ECB officials’ worries. ECB officials scheduled to speak on Friday are Isabel Schnabel, Joachim Nagel and Boris Vujcic.

The US will release the final University of Michigan consumer sentiment index, and the Fed’s Neel Kashkari is also expected to speak.

Read the original analysis here