Our medium term views

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  The View

 The week that will be

  Next week will bring March data for US payrolls and the Eurozone flash inflation print. In any normal week they would be vying for star billing in the market's line-up of events, but both are likely to fill supporting roles to the reciprocal tariff announcements scheduled for Wednesday.

To the extent that tariff uncertainty is reduced after Wednesday, that's good news perhaps. Markets hate uncertainty, as the saying goes. However, there's the other market saying that it's better to travel hopefully than to arrive.

For the Eurozone, our interpretation of "reciprocal tariffs", in isolation, should not present too great a threat; the concern is that scope is broadened to encompass VAT and (actual or perceived) non-tariff barriers.

Downside risks to growth leave us constructive US and Euro rates. For the Eurozone, where we are received Dec ECB €str and where we recommended longs in 15y OATs last week, a headline print of 1.9% for CPI with core at 2.3% (our economists' call), should be a more immediate help. A sub 2% print, if realized, should also be supportive of our US-Euro 2y3y inflation widener idea.

Being month- and quarter-end, thoughts turn to front-end liquidity. Here we expect a smooth passage in the US, especially after the Fed's additional SRF operations.

And we must also spare a thought for month-end index extensions, where it's worth flagging the 0.18 increase for Euro linker indices, with the March 2026 OATei issue exiting (the first of three consecutive month-end exits, to give a cumulative 0.6 extension by end-May).

The week that was

In an appetizer for next Wednesday's tariff main course, President Trump announced 25% tariffs on imports of cars and light trucks, with the aim of reshoring production. This helped firm front-end inflation (where we favor longs in 1y4y CPI).

The Gilt market's first take on Wednesday's Spring Forecast from the UK Chancellor was favorable, delivering bull-flattening, and this came hot on the heels of a downside surprise for UK CPI (the February print).

A total Gilt supply envelope for 2025-26 that was kept under £300bn and a greater-than-expected reduction in the long-end proportion were both welcomed. However, Gilts had second thoughts on Thursday, selling off versus peers, with skepticism about the achievability of fiscal projections moving to the fore.

  Rates - US

•     Stay constructive belly duration but pay June '25 FOMC OIS on solid data
•  Rate forecasts now lower with near-term slower growth, stable by end '26

Rates super-fly

US rates bear steepened on the week but remain broadly range bound. We expect this will persist through April 2 tariff announcement & April 4 payroll data (our economists base case = headline NFP 185k & 4.1% U-3). Clients generally suggest low confidence in the April 2 announcement & expect another solid labor market print.

The US rates market is stuck between soft & hard data. Soft data points to a slowdown but hard data remains resilient; upside inflation risks persist. The recent spike in trade related uncertainty is a headwind to growth, but unlikely enough to materially push rates lower unless the data weakens. In 2019, higher trade uncertainty coincided with weakening US data surprises & pushed rates lower (Exhibit 4). Today, trade uncertainty measures are higher vs '19 but US rates have been unable to break the bottom end of recent ranges as US hard data remains stable & data surprise sideways. It will take a break in the hard data to justify Fed cuts & lower rates.

As the market waits for hard data to confirm the data turn, we like to pay June FOMC OIS. Rates markets are pricing what we believe is too high a likelihood that the Fed will deliver a 25bp rate cut in the June FOMC meeting, which takes place June 18 and will have one FOMC meeting preceding it on May 7. We think that June is too early for the Fed to decide given high levels of uncertainty in its outlook that will take time to see in the data. We recommend paying June FOMC at 4.15% (see Pay June FOMC OIS).

Other trade views: duration: fade extremes in sentiment swings until hard data provides a clearer signal, we suspect a near-term range of 4.15-4.5% & soft long bias in that range; curve: continued steepening bias in 5s30s as it may take more time for near-term cuts to be realized; inflation: long 1y4y inflation swaps given tariff risks, express duration long with mix of nominal & reals to hedge inflation.; spreads: short 30y. We essentially favor a US rates super-fly: paid very front end, constructive on belly, underweight long end.

Lag of soft vs hard data + data most predictive for US rates

Clients have asked how long until the soft data materializes in the hard data. There is no specific economic rule but we have generally assumed the soft data could be head fake if hard data does not soften within 3-6m.

One can also examine the likelihood of slowdown and downturn scenarios extracted from the dynamic of leading indicators to get a sense of timing in the sequencing of a slowdown in data. In a gradual slowdown process that eventually culminates into a recession like the '08 recession, we generally see a 12-18m lag between the pickup of slowdown likelihoods (slowing soft data) and the spike in downturn likelihoods (slowing hard data). Our analysis suggests an uptick in slowdown risks in early '24 that could see clearer signs of a downturn in early/mid '25.

  Rate forecast revisions: 10y at end '25 to 4.5% from 4.75%

The market has clearly re-priced downside growth risks in the rates market, though there are signs of recent stabilization. In our rate forecasts we now take on board these downside growth risks + our economists recent growth forecast changes (see A little stag-, and more -flation). Our economics recently downgraded their 1H25 growth expectations to better reflect trade policy developments and the recent data flow. They marked down 4Q/4Q growth this year from 2.3% to 1.8%. The also raised inflation projection & now expect core PCE to reach 3.0% y/y in 2H25. Faced with modest stagflation, they see Fed on hold.

We revise our US rate forecasts to reflect the downgrade of US growth expectations. We see 10y rates lower at end '25 from 4.75% to 4.5% to reflect near-term softening of growth + market pricing of elevated Fed cut risks.  These forecasts are within our recent estimates of 10y UST fair value (see model update). Our forecasts are modestly above the forwards across the forecast horizon recognizing an overall strong US economy & limited spillover to hard data thus far. A Fed on hold is the BofA modal view but our forecast revisions reflect a market that may price greater downside growth risks.

 Our forecasts also imply a continued cheapening of back-end USTs vs OIS. This is consistent with ongoing concerns about UST supply, deficit risks, & potential disappointment from elevated expectations for financial de-regulation.

Our rate forecasts suffer from higher uncertainty vs usual given upcoming risk events. Specifically, the tariff announcement on April 2 has a very wide range of outcomes & market impacts. The March employment report on April 4 could also meaningfully shift Fed expectations if it either confirms or refutes recent sentiment data.

Bottom line: hold soft long duration bias in belly & in 5s30s steepeners. Be paid June FOMC OIS given sticky inflation & recent solid hard data. Rate forecasts shift lower near term but remain stable over medium term.

  Rates - EU

• We remain bullish duration. We discuss upside to 2025 EGB and EU supply. We believe extra bond issuance for 2025 is almost purely a German story at this stage.

Supply: updated forecast range for EGB & EU supply

 Germany: additional funding likely to be covered with bonds, not just bills

The Finanzagentur release its Q2 funding update on Monday. No changes were made to the Q2 issuance calendar. However, the agency noted that it would consider re-introducing 7y auctions in H2. This has challenged our prior that increased funding needs in Germany may be mostly covered by bills.

We estimate that German 2025 borrowing needs for 2H25 could increase by €25-60bn (Exhibit 7). This is based on the new treatment of defence spending above 1% of GDP, our understanding of the likely revision to the borrowing authorisation for 2025 (due to lower growth), and the potential increase in the defence spending target. The range is wide, but we aim to update it when the 2025 budget is put forward.

We believe that an increase of up to c.€35bn could be funded by a combination of 7y auctions and bills (maintain the bill to bond supply ratio at 1:2, as per guidance from the Finanzagentur). Our estimate for such supply is in Exhibit 8. If the needs are higher, additional increases to other lines would required. This is something the agency has not ruled out but it believes would not be significant. It is worth nothing that the Finanzagentur has excluded a return to selling linkers and does not consider ultra long bonds (given elevated rates), retail bonds, or secondary market sales of own holdings.

Other EGBs: near term focus likely to be on the use of EU's SAFE loans

Besides Germany, we believe EGB supply will not be altered much compared to the funding plans laid out at the start of the year. We previously estimated that Italy and Spain are the two countries with the largest EUR billion gap in defence spending vs the 2% NATO threshold (around €10bn), with Ireland and Austria displaying the largest ppt of GDP gap - see Rates EU in Global Rates Weekly, 21-Feb. We still believe most of these countries' ability and willingness to add to 2025 national spending is limited.

Our baseline is that extra 2025 issuance for defence spending across EGBs (ex Germany) is likely to be less than €10bn. Instead, periphery countries may focus their attention on joint EU programmes, preparing plans to make use of EU SAFE loans (see below) if no other (more attractive) programme is considered by the June summit.

Italy: Given elevated debt/GDP, Italy's ability to increase its deficit is very limited, as is the political appetite to do so for defence spending. But the government ruled out the repurposing the existing EU funds (Recovery and Cohesion) for defence. Our baseline is that it will make use of the new EU programme, while maintaining the pressure for expanding the toolkit at European level (see Europe Economic Weekly, 21-Mar).

Spain: Similarly to Italy, Spain also grapples with high debt to GDP levels (104.3%) limiting the incentive for additional borrowing. PM Sanchez expressed his intention to outline and start implementing a plan to boost defence spending before the summer. However, Spain has been unable to pass a budget for 2025 yet and may have to roll their 2023 budget again for this year. This could push plans for defence to the 2026 budget.

Portugal: After the no-confidence vote of Luis Montenegro's government, a snap election was called for this May. Until then, the interim government must continue with the existing budget. After that, deriving a new budget will also take time. Additionally, the two major parties appear to continue prioritising fiscal prudence.

Belgium: As a share of GDP, defence spending in Belgium has been similar to that in Spain & Italy (c.1.3%) but the gap in bn is smaller at c.4bn. Still, it is a sovereign to keep an eye on. After a prolonged period of political uncertainty and large fiscal deficits, Belgium was able to form a new government earlier this year. This one now aims to raise defence spending to 2% as early as this year, and targets to submit the 2025 budget by mid-April. This could present a challenge given fiscal consolidation needs.

EU: we continue to believe additional funding in '25 will come mostly in bills

In Feb, we noted that the EU has significant room to increase its short-term funding to cover additional needs in 2025 (scope for c.€30bn increase in stock of bills, and an envelope for repo funding of €60bn). We envisaged an extra €10bn EU bond supply in 2025 to speed up disbursements to Ukraine (total of €170bn, as per current limit).

Since then, the EU announced a plan for a new financial instrument (the Security Action for Europe - SAFE which will provide Member States with up to €150 billion of loans backed by the EU budget). This instrument will be funded by EU issuance, raising questions over added 2025 bond supply. We read the details and EC Q&A on the topic as supportive of our view that EU bond issuance will not increase meaningfully this year:

1. The maximum amount of additional needs related to SAFE this year = 15% pre-financing of agreed loans. In the very optimistic scenario where a large number of countries request loans up to the maximum of €150bn, and their plans are all approved in 2H25, this pre-financing would represent €22.5bn of extra funding needs for SAFE. The realised amount can be meaningfully lower than this.
2. The Commission noted that it will be able to accommodate disbursement needs with the "flexibility provided by its unified funding approach". And that "this will limit the changes to its envisaged bond issuance through 2025 and 2026". We believe this is a reference in part to bill and repo funding being used to bridge this period over which there is still net NGEU-related bond supply.

We recommend buying EU 10/54 vs NETHER 1/54, at 72bp, targeting 60bp with a stop at 80bp. The risk to this trade is the announcement of a large increase in EU supply.

Stay long rates: receiving Dec ECB €str & long 15y France

We remain bullish duration (in very front-end as well as via 15y France). Our benign view on bond supply is only a small part of the story. We are also focused on: (1) inflation prints next week, with our economists expecting 1.9% headline inflation, (2) the US tariffs due on Apr 2^nd. Even if levels end up low for the Euro Area, it is unlikely that uncertainty will fade, (3) an ECB increasingly of the view that tariffs will be net negative for growth and thereby inflation, opening the door for pricing of sub 2% terminal rate.

   Rates - UK

• Gilt Remit did not disappoint and we hold onto long G vs. WN invoice spreads. We also update our yield forecasts post macro data & Spring Forecasts.

Flexible benefits

2024-25 CGNCR estimate likely to increase in April

The DMO raised its CGNCR for the current FY by £7.5bn to £172.6bn vs. the October update (Exhibit 9). With NS&I incl. GSBs projected to raise £0.8bn more than the expected £9.5bn target for 2024-25, the NFR for the current FY is expected to turn out £6.7bn higher. With the CGNCR running £22.3bn ahead of plan as of February 2025, we suspect that this carry-over to the upcoming FY will see a further increase in April.

For 2025-26, the CGNCR is expected to be £142.7bn - not far from our expectation of £144.8bn. The £168.2bn of redemptions and £6.7bn in carry-over from the current fiscal year mean that GFR will amount to £317.6bn, while the NFR is forecast to be £304.2bn (note that proceeds from NS&I in 2025-26 are projected to come within a range of
± £4bn). Of that, planned gross Gilt issuance of £299.2bn next FY will be only marginally higher than this year's £297.0bn, in line with our thinking, while net T-bill sales will contribute £5bn. If the carry-over indeed turns out to be higher in April, we expect this additional 2025-26 funding need to be reflected in higher net T-bill sales.

More ambitious DMO amid high effective Gilt sales

A sharper-than-expected reduction in long Gilt sales (14% share vs. our expectation for 16%) was welcome, but it came with higher-than-anticipated unallocated portion of Gilt sales of 9%, expected to increase to only 5% by us and the primary dealers polled by Bloomberg. In the absence of the newly introduced programmatic Gilt tenders, we would have viewed this as signalling a greater upside risk to the share of long Gilts as the year progresses. But the tender program tempers that risk to an extent, in our view.

We interpret the DMO's increased flexibility to vary the split of issuance and the mix of distribution methods during the year as positive and more ambitious considering the persistently high effective Gilt sales to private investors in 2025-26 and beyond. Here, it is important to highlight changes in DMO's illustrated GFR projections, which were revised up by a cumulative £80.4bn over 2026-27 to 2029-30.

The BoE's QT plans from October 2025 are unknown (our base case is that the BoE would not rush to pre-empt the QT pace decision before August). We think it unlikely that that BoE would raise the pace from current £100bn per QT year, but it is possible that it would reduce it. At extremes, an unchanged BoE QT pace in 2025-26 would result in higher effective net Gilt supply from the DMO and BoE combined while passive QT only in 2025-26 would result in a small fall in effective net Gilt sales than this year.

Remit supportive of our ASW bullishness

Heading into the Remit, we highlighted the 10y area on the Gilt ASW curve as an attractive point to be long, from cross-market, relative value and carry perspectives, with de-regulatory potential on the back of developments in the US posing potential further upside (Buy 10y Gilt vs 30y UST invoice spreads, 28 February). With Wednesday's Gilt Remit not disappointing our expectations, we hold onto our long G vs. WN invoice spreads. Current: 22bp. Entry: 13.9bp. Target: 30bp. Stop: 5bp. Risks to the trade are credible deficit reduction discussion and/or a broader reduction in dealer capital requirements in Treasury financing and warehousing on the US side, a sharp increase in Gilt supply in April and/or broad market risk-off.

Rate forecast revisions: marking-to-market post macro data & Spring Forecasts

Our economists continue to expect the next Bank Rate cut in May after this week's decline in February headline inflation and more backloaded than expected fiscal consolidation measures in the Spring Forecast (see Inflation Review and Spring forecast Review, both 26 March). More data points on inflation and labour market, along with tariff news, will be important for May rate cutting prospects. Our base case remains three cuts this year and one in 2026, with risks tilted towards less. Our front-end Sonia forecasts lie increasingly below the forwards through forecast horizon given current market pricing of just under 50bp of cuts priced in for 2025 and terminal at around 4%.

Our forecasts imply more 2s10s Sonia steepening than the forwards, stemming mostly from our bullish front-end forecasts relative to forwards. We are broadly neutral Sonia relative to the forwards in the 10y, but pencil in some Gilt performance relative to swaps in the shorter end of the curve. We expect the DMO to deliver on their increased flexibility to vary the split of issuance and the mix of distribution methods during the year, helping to cap duration supply concerns into Autumn and beyond (for 30y, we think good news are now in the price). BoE QT slowdown in September and/or de-regulatory potential on the back of developments in the US are other potential upside risks.

 Rates - AU

•   We see the RBA on hold in April but continue to expect a cut in May
• We reiterate our long bias through buying YM, hedged by paying August '25 RBA.

Australia: No cut in April? April Fool's

We expect the Reserve Bank of Australia (RBA) to hold the cash rate target at 4.1% at its March 31 - April 1 meeting, in line with consensus and market pricing (Exhibit 11). As expected, a slightly weaker-than-consensus monthly CPI print (2.7% vs 2.8% expected) was not enough to move the market but a drop in monthly jobs growth and weak CPI sets the stage for a rate cut in May. Our economists expect the RBA to cut in May and November. The statement and press conference are likely to suggest a gradual approach to easing. Communications about this week's budget could skew the statement or press conference a bit more hawkish. Monthly CPI and weak AU jobs growth are a risk to the downside (i.e. more dovish communication) but we think this is less likely.

Reiterate our long bias: Buy YM, hedged by paying RBA

We continue to recommend buying YM and hedge the risk by paying August '25 RBA OIS. The primary impulse for the trade is our view on global rates: elevated slowdown risk in the US means we retain our long bias, especially into April 2 tariff announcements. Yet weak monthly CPI and an ambiguous signal from the last AU jobs report increases our conviction in remaining long. We like the risk/reward of YM longs with 3y rates comfortably above the RBA's estimate of neutral rate and our economists' forecast for terminal RBA cash rates.

Since entering the trade, the structure has moved form -8bps to -12bps (4bps closer to our target) alongside a global rally in front-end rates and slightly weaker AU data (jobs, monthly CPI). The structure will trade long (i.e. outperform in a global rates rally, underperform in a sell-off). This feature should become more exaggerated with the passage of time. That is, as we get closer to August, YM will move in a wider range vs Aug RBA OIS. Our thesis is that slowdown risks will become more exaggerated over time but the risk to the trade is that soft survey data does not translate into hard data over the coming months. The trade is currently -12bps, vs open: -8bps; target: -50bps and stop:10bps. Risk: hawkish communication from the RBA or strong US data.

ACGB f'casts: lower rates, same x-mkt spread to USTs

Our US team has lowered their rates forecasts and we revise our ACGB forecasts to maintain our forecast for cross-market spreads (Exhibit 2) We now revise our 10y end '25 forecasts from 4% to 3.75% and our end-'25 2y forecasts from 3.5% to 3%.

Budget review: back in the red

Australia's pre-election budget focused market attention on swap EFP (Australia Watch 25 March 2025). Net bond supply over the forward estimates were broadly unchanged from the last budget update in Dec '24 but client feedback has focused on the expansionary impulse of fiscal spending ahead of Australia's 3 May 2025 federal election. 10y bond futures are now trading at their cheapest vs swaps in history. Election campaigns are typically characterized by expansionary, rather than contractionary commitments and we see a near-term risk of curve steepening/ swap spread tightening.

Yet the YM/XM curve has steepened beyond our near-term expectations and our fair value estimate (c. -6bps) for 10y swap EFP suggests bonds are trading too cheap vs swap so these risks may already be priced in. the residual (spread vs fair value) is within 1 st. dev. of historical ranges so we have a bias to be paid but there is no clear signal to pay or receive at this point (Exhibit 13 Exhibit 14).

  Rates - JP

• We discuss flows and trades for Japan's new fiscal year starting next week.
• We recommend buying 10s20s JGB curve flattener.

Recommend 10s20s JGB curve flattener

Japan's new fiscal year starts next week. We discuss how the start of the new fiscal year affects domestic flows. Lifers' demand for foreign bonds may emerge but selectively and conditional on market volatility with hedged demand more likely in the EUR space while USD/JPY's and EUR/JPY's dip would be bought for unhedged investments. We see a scope for JGB curve flattening.

Lifers' demand for superlong JGBs to improve in new year but slowly

We expect lifers' demand for JGB to improve after the new year starts next week.

• Convexity-related selling in duration should subside as volatility has peaked out.
• The 30yr JGB yield, at 2.6%, and the 20yr yield, at 2.3% are at their highs during the 2006-2007 hiking cycle. The coupon rate for 30yr and 20yr bonds to be issued in Apr could be 2.6% and 2.3%, highest in 20 years. The superlong sector also appears cheap on the curve and vs swap.
• Lifers' liability cost would be lower than the current superlong yields¹.
• A proper tightening cycle tends to flatten the curve in DM markets. The BoJ frequently quotes their previous study, which showed various estimates of the real neutral rate for Japan ranging from -1.0 % to +0.5%. Assuming a range of nominal neutral rate of 1-2.5%, the 20yr yield at 2.3% and the 30yr yield at 2.6% may no longer be seen expensive especially relative to the 10yr sector (1.5%).

As lifers have been slow to buy JGBs, their lending in the call market increased in 2H24. We think lifers will reduce the cash balance and increase JGB investment in the new fiscal year. However, lifers' demand may not rise all at once. Uncertainty around BoJ policy remains high and the terminal rate assumption may differ across investors.

Therefore, there is still uncertainty around where demand emerges and how strong it will be. While we expect some demand for superlong JGBs from lifers and a scope for flattening, the steepening from mid-Feb may not be fully retraced given increased domestic political and fiscal uncertainty.

Banks' demand may rise but more so with 10yr yield > 1.75%

With the 10yr JGB yield above 1.5%, banks may also buy JGB's dip. That said, if they assume a 1.5% terminal rate, our base case, the current yield at 1.5% may not appear attractive yet. Some clients see the risk of even a higher terminal rate - for example 2%. From this perspective, demand for 10yr JGB may rise but gradually and more so if the yield rises to 1.75% and increasingly so if the yield rises to 2%, which would grant zero real interest rate under a 2% inflation scenario.

Domestic banks also focus on the interim quantitative tightening (QT) assessment at the 16-17 June Monetary Policy Meeting (MPM). As deputy governor Uchida indicated on 5 March², the stock effect depresses the JGB yields, especially for maturities up to 10yrs in our view, while at the March MPM, BoJ governor Ueda signaled continuation of bond purchase reductions in FY2026. The BoJ's pace for Rinban reduction from April 2026 and its terminal offer amounts for each maturity have been key uncertainty for bond market participants (for details, see Japan Watch: BoJ review: Watching and waiting 19 March 2025).

Trade recommendation: 10s20s JGB curve flattener

We recommend 10s20s flattener in JGBs via long JL191 maturing 20 December 2044 vs. short JB377 maturing 20 December 2034. We enter the trade at 73.0bp, targeting 60.0bp with a stop at 79.5bp.

The 10yr yield has a scope to rise given 1) still low level relative to our terminal rate assumption; 2) the BoJ's de facto QT, which would weigh over the 10yr and shorter sector more than the superlong sector. Meanwhile, the 20yr JGB may be relatively supported due to 1) the level that appears more consistent with a 1.5% terminal rate than the 10yr JGB and attractive relative to lifers' liability cost; 2) lifers' potential demand for new fiscal year; 3) a bigger scope for falling for the superlong-end in case of a severe global risk-off.

Risk is increased fiscal risk premium on the back of political uncertainty and delayed rate hikes by the BoJ amid the yen weakness.

 Rates - CA

Themes: tariff risk weighs on rates

Market pricing of BoC terminal, the expected stopping point for the cutting cycle, has continued to trend lower to 2.37% (versus 2.75% spot), even as inflation has surprised higher. Terminal has fallen from over 3% in Jan, largely reflecting fear of trade war impacts and an anticipated dovish policy response.

Policy uncertainty has been a clear driver this year with CAD rates shifting 10-40bps lower YTD with a substantial curve steepening. Canadian swap spreads have also tightened on tariff risk which could drive more govt bond supply on fiscal stimulus.

The terminal rate spread between the BoC and Fed, which we use as a proxy for the US-CAD 10y rate differential, has tightened from a peak of 153bps on Jan 31 to 116b currently, largely on the back of weaker data in the US. Despite this decline, the 2y1y CAD-US terminal rate spread is still at historical wides. We expect it continue to compress closer to recent historical norms of circa 50bp.

If the expected policy rate differential continues to narrow, it should favor a 2-10 CAD curve flattener vs a 2-10 US curve steepener. This would express our view that 1) if tariffs are bad, the US could wind up cutting more than expected while CAD delivers more along the forwards, or 2) if US-CAD trade tensions subside, the CAD curve can price out more cuts while the slowing US trajectory continues for other reasons including policy uncertainty around health care and reduced government spending.

Forecasts: in line with forwards

Our rates forecasts are now in line with the forwards. We revised rates forecasts lower after our economist adjusted BoC call for a 2.5% terminal.

Risks: skewed to the downside

We see risks to our forecasts as skewed to the downside given potential for further BoC cuts if tariffs prove to be more permanent.

  Front end - US

• While we continue to expect a late debt limit resolution ahead of the August X-date, recent headlines highlight the risk of an earlier debt limit resolution.
• An earlier DL resolution poses a challenge to crowded front end spread longs & makes us less constructive on front end spread widening

Debt limit timing risk has shifted

DC developments this week suggest increased Senate support to include a debt limit (DL) increase in their budget resolution draft. The Senate would reportedly like to vote on this resolution before Easter & then work with the House to finalize & start drafting the law. This raises the risk of an earlier debt limit resolution, potentially as soon as Memorial Day. DC developments cause us to increase odds of DL resolution by Memorial Day up to 40% & reduce our baseline of a late July / early August increase to 60% odds. We hold our X-date in late August, well within CBO projections.

Earlier debt limit risk lowers front end spread conviction

The earlier DL resolution risk lowers our conviction in being long front-end spreads. Earlier DL resolution means fewer bill cuts, less drawdown in TGA, & a shorter period of easy funding. Client feedback also suggests the front end spread long is a crowded & frustrated trade. We find the risk / reward in this trade to be less favorable, especially given the very large bill issuance expected after DL resolution.

Funding has been sticky & window to drop is narrowing

Clients report frustration with relatively sticky high funding conditions despite recent bill supply cuts (see Funding notes). We still expect funding to soften once we are past the typical quarter-end dynamics & net UST supply turns negative from April - June, but the window for the soft funding period is at risk with shifting odds of DL resolution timing.

Lower bill paydowns => higher TGA => tighter funding

An earlier debt limit resolution risks less TGA drain and fewer bill cuts than in our base case forecast. A late May debt limit resolution would imply a higher TGA trough vs our base case scenario (Exhibit 20) due to significantly fewer bill paydowns (Exhibit 21).

Early debt limit resolution is risk to spread widener

An earlier debt limit resolution is a developing risk for the crowded front-end spread long. A sudden suspension or increase in the debt limit could result in a sharp tightening on the unwinds. To help inform our analysis we ran 2 regressions that compared 2y swaps spreads to (1) UST bill supply and (2) marketable debt outstanding ex Fed under both a May DL resolution scenario and an August DL resolution scenario. We found that an earlier DL resolution would imply 1-4bp tighter 2y swap spreads (Exhibit 22, Exhibit 23).

$4tn DL increase could become constraining by Nov '26

The current House reconciliation bill that is being considered in Congress includes a $4tn debt limit increase. A reconciliation bill allows for Republicans to raise the debt limit with a simple majority, instead of the typical 60 votes needed in the Senate. Precedent around debt limit increases under reconciliation have historically been a $ increase, rather than a suspension, which leads to greater uncertainty around the timing of the next debt limit episode.

We estimate that a $4tn DL resolution would likely mean the Treasury will hit the debt limit again sometime between Nov '26 and Mar '27 depending on how deficits develop. The risk of hitting the debt limit again in Nov '26 around mid-term elections would be politically challenging for Congressional re-elections.

Bottom line: While we continue to expect a late debt limit resolution ahead of the August X-date, recent headlines highlight the risk of an earlier debt limit resolution. An earlier DL resolution poses a challenge to crowded front end spread longs & makes us less constructive on front end spread widening.

         Spreads - EU

• German swap spreads tightened vs US, which can tighten the EURUSD xccy basis
• We see room for 10y xccy basis to tighten c. 11bp but are mindful of three risks to this view

German swap spreads tightened vs US…

Swap spreads in the US and Germany so far this year have been driven by expectations over US deregulation, US deficit, and European defence spending. On a relative basis, German swap spreads cheapened more vs US swap spreads in the 5y and 10y than the 2y: the 10y German swap spread is c. 15bp tighter than the 10y US swap spread YTD (Exhibit 24). In contrast, the 2y relative swap spread is largely unchanged YTD.

… which can tighten the EURUSD xccy basis

Relative swap spreads can explain between 80% and 90% of recent EURUSD xccy basis levels (Exhibit 25 and Exhibit 26). As German swap spreads tighten vs US swap spreads, issuers may find it more attractive to raise euros by issuing US dollar debt and swap the dollar proceeds into euros, rather than issuing euro debt directly. Investors may also obtain a higher FX-hedged pickup from German assets over US assets, all other things being equal. Both types of transaction may raise demand to borrow euros via the EURUSD xccy basis market and put tightening pressure on the basis.

We see room for 10y xccy basis to tighten c. 11bp…

The YTD tightening in the 10y German swap spread vs US swap spreads would imply c. 10bp tightening in the basis based on their historical relationship. But the xccy basis widened 1bp YTD. Therefore our calculations suggest room for c. 11bp tightening in the 10y EURUSD xccy basis based on swap spreads alone (Exhibit 27). The same analysis suggests room for c. 8bp of tightening in the 5y EURUSD xccy basis.

… but are mindful of three risks to this view

Our calculations assume relative bond asset swap valuations do not change further. This may be challenged and we see three risks to this view if 1) US swap spreads tighten on the reversal of widening associated with deregulation expectations, 2) the return of fears of high US deficit paths (see US Rates Watch, 13 March 2025), and 3) if euro credit spreads remain resilient and US credit spreads condition to widen (Exhibit 28).

Front-end basis fair from swap spread perspective…

At the 2y, we see little discrepancies between 1) YTD movements in the xccy basis, and 2) what YTD relative swap spread movements imply.

… but tightening pressure may build from QT divergence

The US Federal Reserve announced a reduction in its pace of QT and our US colleagues now expect QT to end in December 2025 (see US Rates Watch, 19 March 2025). In Europe, our base case remains for the ECB to continue QT in the foreseeable future. This means euro reserves will become increasingly scarce vs US dollar reserves, especially as the US TGA is drawn down (Exhibit 29), which we expect to sustain tightening pressure at the front-end of the EURUSD xccy basis curve and the EUR FX-Sofr basis.

  Technicals

Summary: Macro technical strategy begins here

In 2025 we strive to evolve the Technical Advantage report into a multi-asset class recap of technical views heading into or out of macro events and key data releases. Over time and as the charts prove to be technically relevant, we will swap assets in and out. A summary of our shorter-term multi-asset technical observations follow as markets head into so-called Liberation Day on April 2nd and US labor market data on April 4th.

US 10Y Yield: Possible top if below 4.45-4.50%

Our view was to fade the YTD decline in the 4.20s and look for a bounce back in March. This has occurred. Yield is approaching technical resistance at about 4.45%. While below, a head and shoulders top may form. But if it breaks higher above the declining trend line and 50d SMA, upside risks develop. The left shoulder high at 4.50% is the last textbook level that could be considered for a top formation or 4.10-4.50% range. Above 4.45-4.50% and risk tilts to higher yields into May such as 4.66%, 4.80% and maybe 5.00%.

US 5s30s: Year ahead target of 60bp reached, raise stop

Our top 2025 year ahead trade was a 5s30s steepener. We remain of the view that the curve steepens over the medium-term and take this opportunity to again raise our stop to 45bps, which is just below the last tail low on March 19 of 47bps.

Euro has run ahead of the 2017 analog, buy the dip

We're bullish euro since the hammer candle at the 1.02 Fibonacci retracement level and the subsequent double bottom that followed. The 4Q16-1Q17 analog continues to repeat which means euro continues higher in 2Q25-3Q25. We're buyers on dips at key levels such as 1.0727, 1.0644 and 1.0548 and look up to levels such as 1.10, 1.1150, 1.1205. Below 1.05 would be a concern. If the size of the rally in 2017 repeats, euro can see upside of 17-21% which puts the 200m SMA near 1.20 on our radar in a years' time.

S&P 500: April seasonal showers must hold 5500 support

In the short-term, we expect April seasonal weakness to result in a retest of the 5500-5512 support level. From here, we look for signals of a double bottom and resumption of a 2Q18-3Q18 repeat rally. However, we're in a cyclical bear market. A break of support at 5500 means no early bottom and creates downside risks to 5392 and the 5120s.

LME 3m Copper: No bullish breakout, two sell signals

After forming a head and shoulders base in Nov-Feb with upside to about 9800, copper prices continued further to retest the trailing highs at about 10158. Markets bearishly reversed as a TD Sequential sell signal and bearish MACD cross occurred. Altogether this suggests copper prices are mean reverting / retracing the prior up move to levels such as 9625 and possibly 9460 (provided no sustained breakout higher occurs soon).

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