Yield outlook: Upside risks dominate

10Y US Treasury yields have remained relatively stable around 4.40-4.50% following the sharp increases after Trump's 'Liberation Day' in April. President Trump's trade rhetoric has softened, and key economic indicators have stayed largely on track. Meanwhile, slightly softer US inflation figures have bolstered market expectations for a more accommodative stance from the Federal Reserve. The realisation of this scenario largely depends on the repercussions of the ongoing Middle Eastern conflict. The US's direct involvement in the Israel-Iran dispute heightens the risk of significant shocks to energy prices, particularly if the Strait of Hormuz's energy transit is disrupted. Should this occur, attention may revert to the necessity for tighter policy measures. See Research Global - What if Iran closes the Strait of Hormuz?, June 22.

The risk remains tilted to the upside

In the long end of the US curve, we perceive the predominant risk to be on the upside across regions. The Trump administration's substantial tax package, dubbed 'The Big Beautiful Bill', is anticipated to worsen the US government's deficits, posing a significant risk that long-term US rates may adjust higher as these deficits exert direct pressure on the market through increased bond supply. Consequently, the market will be sensitive to the Treasury's funding strategy, which will effectively decide the extent of additional duration private investors will need to absorb in the years ahead.

The funding strategy will be clarified once Congress lifts or suspends the current debt ceiling, which presently restricts new debt issuance. The deadline for this is set for August, after which the government will be unable to meet obligations. In response to concerns about potential increases in long-end rates linked to the package, the Trump administration is exploring financial deregulation, allowing banks to hold more government bonds. However, we anticipate this will play a minor role in the short term. Our forecast for long US rates remains close to current levels, yet we see the risk trajectory pointing towards even higher rates over the next 12 months.

The ECB is nearing the end of its interest rate cuts

In the euro area, June also brought plenty to monitor due to trade threats from the Trump administration, whose outcomes are yet to be seen. The ECB lowered its deposit rate by 25bp as expected, but ECB President Lagarde's signals were surprisingly optimistic about the current rate level. The ECB's signals indicate that the threshold for further easing has been raised. We expect one more rate cut in September, and we see the risk leaning towards another cut by the end of the year. However, we have revised our expectation for the endpoint of the ECB rate from 1.50% to 1.75%—for Denmark, from 1.10% to 1.35%—which primarily reflects our view on Danish/European swap rates with maturities of 5 years or less. 

At the long end of the European/Danish yield curve, uncertainty - similar to the situation in the US - is also skewed upwards, although our rate forecast predicts the level to remain around the current state. Beyond the US debt outlook, which also impacts Europe in terms of long-term rates, other factors are currently at play that could prompt an increase in rates.

Several countries continue to significantly boost defence spending, and the Middle Eastern conflict risks are driving inflation expectations to a level that may again unsettle central banks. However, downward risks to growth/inflation should not be neglected due to trade policy uncertainty and the persistently pessimistic sentiment currently deeply rooted across households in the US and Europe.

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