Our medium-term views

 Our key forecasts

  What we like right now

  The View

 The week that will be

  The main event of the week remains today's NFP print, especially considering the weaker data flow this week. Our economists expect an above consensus print of 150k, but flag downside risks. Given considerable changes in migration flows, markets may pay more attention to the unemployment rate.

The key uncertainties for the US economy, however, are unlikely to resolve themselves. An eventual slow-down in activity has to be expected given the tariff shock and related trade policy uncertainty that will weigh on capex, and very much remains part of our and the consensus base case. However, the Fed will have to weigh these downside risks to growth against upside risks to inflation of which we may see the first signs in next week's CPI and PPI prints. And the Fed's reaction function will also depend on the reconciliation bill and the accompanying fiscal impulse. We remain short the US front-end and long US breakevens.

Further out the curve, the reconciliation bill matters not just for its impact on activity and inflation, but also because of its impact on supply and potentially also its impact on demand for US assets via Section 899 (see Liquid Insight 4 Jun 25). We remain in 10s30s steepeners and short 30y on ASW (see US Rates Viewpoint 5 Jun 25).

UK April GDP data is an important hard data read on the post-tariff world. Our economists are looking for a negative print, which should help our bullish cross-market real yield view vs the US. Also in the UK, BoE Saporta's speech should provide further evidence as to the BoE's thinking on QT. We remain confident that QT tweaks are coming also benefiting Gilts cross market and on ASW.

Finally, we will be looking at the latest set of flow data from Japan for evidence of where investment flow has been skewed since liberation day.

The week that was

The ECB surprised us (and the market) with hawkish communication today, clearly demonstrating the Governing Council's desire to pause the hiking cycle. Dec-25 €str repriced c 8 bp on the day and markets are now discounting just one more full cut for the year. Our economists have revised their call to take out the July cut, but still see forecasts forcing the ECB to cut in both September and December (see Euro Area Watch 5 Jun 25). We continue to see value in EUR real yields.

ISM data in the US surprised on the downside and jobless claims on the upside leading to a sharp outperformance of US rates cross market even before the hawkish ECB meeting. As we flag above, we are not sure that these data have justify this type of market reaction but are further evidence of cleaner positioning (see US Rates Watch 2 Jun 25).

AU rates rallied and the curve bull steepened this week after a weaker-than-expected GDP print but our economists see signs of underlying strength in private consumption and investment. We stay short Dec '25 futures vs 3y bond futures.

  Rates - US

• We retain our underweight bias at the front end of the curve; payrolls may continue painful curve flattener move.
•  Supply/ demand concerns risk migrating to the front end & funding markets post debt limit.

Flattener pain trade risks persisting on payrolls

Duration saw a modest bid & curve flattened following softer than anticipated ISM manufacturing & services data. Last week we recommended paying SOFR Z6 at 3.26% (current= 3.30, target = 3.9%, stop =2.75%) to position for a market that will begin to question why the Fed is cutting at all. While data so far this week has not endorsed this narrative (Exhibit 1), payrolls printing above expectations as our US economics team expects (150k vs 125k) could support the trade.

Payrolls data could retain a flattening bias on the curve either way. If data proves stronger than expected, curve will likely bear flatten as market removes cuts through '26. If data is weaker than expected, this could give asset managers the go ahead to extend duration further out the curve as their positioning has been skewed steeper & concentrated in shorter tenors (see: Weekly flows report, Exhibit 5).

We retain our underweight duration bias at the front end of the curve. As discussed below see risks that the supply/ demand imbalance migrates to the front end which could support incremental cheapening particularly post debt limit. The market has increasingly focused on Treasury WAM shortening as the path of least resistance to support the UST market. We have sympathy for this view but acknowledge it only works until shorter tenor demand is exhausted (for more detail see: 5 June 25 Viewpoint).

UST WAM reduction may be passive or active

Following a WAM issuance reduction from the UK DMO (see: Revised remit) & signals that the Japanese MoF will reduce long end issuance in July, a WAM shift from UST is generally believed to be a matter of when, not if. We also believe it is inevitable that UST shortens their WAM & relies on shorter-tenor funding given the back-end supply / demand imbalance and historically elevated levels (Exhibit 6). However, signal that UST will reduce WAM of issuance lower may not be explicit.

Rather than UST guiding for a shift lower in WAM at the August refunding through shorter coupon issuance, we see risk that Treasury simply accepts an implicit WAM shortening through higher bill issuance. Treasury Secretary Bessent is unlikely to endorse a near-term increase in coupon sizes given his optimism that the upcoming tax bill will reduce the deficit. Instead, Treasury is likely to retain its signal of stable coupon sizes until the deficit proves otherwise (which may take several quarters after the tax law passage). Until auction sizes are increased, Treasury may rely on bill supply. Treasury is likely to accept an implicit WAM shortening until the tax law deficit impact is clear.

Squeezing the supply balloon

A Treasury that relies on more bill supply will test demand from front-end investors. Bill demand has been strong due to elevated US money market rates, money fund inflows, & recently restricted bill supply due to the debt limit. We expect bill demand will be tested amidst a large surge in bill supply after debt limit resolution (We expect ~$950b bill supply from Aug to Nov '25 (Exhibit 7, see: US front end).

If funding market rates become disorderly or trade above the top end of the target range, the Fed will step in to stabilize money markets. It may well be that UST supply is squeezed hard enough towards shorter-dated issuance tenors such that traditional private sector demand is exhausted & the Fed is required to provide support.

Overall, we would not be surprised to see Treasury implicitly rely more on bill supply over coming months until the deficit impact from the tax law is clear. If Treasury relies too much on bill supply, it will cause money market rates to reprice meaningfully. This re-pricing could force the Fed to intervene in money markets (initially vs SRF, eventually via outright bill buying) & provide the ultimate UST market backstop role. Said differently, Treasury may squeeze the UST supply balloon enough to ultimately trigger Fed support; Fed support is likely easier found at the front end vs long end.

Bottom line: We retain our underweight bias at the front end of the curve and hold our pay SOFR Z6 position. Payrolls could be a flattener either way given steepener positioning from the asset manager community that is shifting less in the money. We see risks that supply/ demand concerns migrate to the front end of the curve and funding markets if explicit WAM shift or passive increases in bill supply post debt limit.

  Rates - EU

• The ECB surprised with hawkish guidance, signalling that the bar for additional cuts from here is elevated. We revise terminal higher and tweak our rate forecasts.
• We see scope for German curve to be resilient to swaps & global curve steepening.

ECB hoping for the best, not really preparing for the worst

The ECB likely wants to stop after this week's cut. While the guidance in the written statement still emphasizes meeting-by-meeting and data-dependence, Lagarde during the press conference made an effort to implicitly signal that, unless data surprises them to the downside, policy rates are in a good place.

As a result, our economists are now revising their call, no longer expecting the ECB to cut policy rates in July, but still expecting them to do so in September and December. Thereby, our baseline for the Depo rate by year-end moves up, from 1.25% to 1.50%. Our economists were already working under the assumption that it is data that would push the ECB to go lower from here. But the extra resistance we saw today probably means the bar (in terms of surprises) is higher than we thought and, probably, further moves are likely to only happen in meetings with new forecasts.

It seems the ECB has turned more forward looking, given the insistence from Lagarde on ignoring the inflation undershoot in 2026 headline given that 2027 goes back to 2% (but not core, stuck slightly below 2%). And this is despite those forecasts being a bit of a best-case scenario, where the German fiscal package has a strong impact and tariffs do not get worse from here (an optimistic scenario in our view).

But this is a concerning reaction function. Just a few weeks ago, our economists argued that the ECB would not tolerate a persistent inflation undershoot since that would be equivalent to implicitly acknowledging that the old asymmetry (close to but below 2%) is still there. It proved costly before, and it could prove costly again. This is a key reason why we still think the ECB will end up continuing to take policy rates lower in 2H25. But this week's meeting leaves us a little more worried about that.

Hawkish ECB => higher rates, flatter curve, but moves could have been larger

The market was quick to interpret the ECB press conference as hawkish, with president Lagarde addressing the question of a potential pause in July by stating that the central bank was now in a good place, with inflation forecasts settling well at target.

Overall, forwards moved from pricing in 6.5bp of cuts for the July meeting, to only 3bp (<15% probability of a 25bp cut). The implied terminal €str rate rose by c.9bp, to 1.66%.

Moves could have been arguably larger, as we are still implying a full 25bp cut by year-end. Like us, market participants are probably acknowledging that the tariff risks and uncertainty ahead, in the context of rapidly falling inflation, can end up pushing the ECB to deliver more.

On the curve, the ECB meeting resulted in a flattening, which was more significant in German bonds than in swaps. We believe this divergence can extend and see room for the German curve to flatten vs swaps and other regions (US and Japan specifically):

• This new ECB stance means that, until the negative growth risks prove significant, the front-end may not rally much / drive much steepening. At the same time, bearish pressures in the long-end due to supply can be limited over the next few quarters.
• The steepening trades entered to position for the Dutch pension fund reform flows are likely to concentrate more in swaps than in bonds, and could be more focused now on the 20s50s and 30s30s rather than in the sub 30y part.
• Even after today's move, the German curve still appears too steep compared to what global bond curve dynamics would have implied, displaying around the same residual as the US curve, and a larger one than in Japan - see Exhibit 8 & Exhibit 9.

We tweak our German bond and EUR swaps forecasts marginally, to account for our new economics baseline of cuts to 1.50%. New forecasts are in Exhibit 10. We are mostly making changes to our front-end forecasts for the next few quarters, with the increases fading over time as we were already projecting the market would price in rate hikes for 2026 and beyond. Changes versus our previous forecasts are in Exhibit 11.

EGB spreads to Bunds managed to tighten in the duration selloff. But we are cognisant that the new ECB messaging could somewhat dampen the appetite for carry that we observed since March, reducing the potential for continued strong resilience in periphery spreads should there be a negative shock in the broader risk complex. We continue to favour SP, with a long position in 10y on a PCA credit fly vs IT & GE (current: 21.7bp, target: 15bp, stop: 31bp). The main risk is growth underperformance in Spain.

   Rates - UK

• We expect the BoE to reduce the stock of Gilts by £60bn in the next "QT year".

Quantitative Tiptoeing

BoE to reduce QT annual run rate to £60bn from October

We now expect the Bank to reduce the stock of UK Gilt purchases held for monetary policy purposes by £60bn in the next QT year starting in October, from £100bn in the current. Our thinking on QT pace reduction is primarily based on our scepticism that QT is really operating in the background, but it also seems like a sensible step to take with the end of abundant reserves in sight (for more, see UK Viewpoint, 6 June).

With £49bn of "passive" QT due in 2025-26, our base case implies £11bn of "active" QT from October 2025, so not dissimilar to the current year's £13bn (Exhibit 12). In this note, we will explore some alternative scenarios for 2025-26:

1. OBR's March assumption of £48bn active QT throughout;
2. £50bn total QT (the minimum not requiring reinvestments in the near term);
3. £75bn total QT (the median expectation in May Market Participants Survey);
4. £100bn total QT (unchanged relative to the current year).

Active and passive QT splits until QT year 2029-30 under different scenarios including our own base case are shown in Exhibit 13.

QT impact: more profound than BoE contends, we think

Although correlation is not causation, we do regard the QT pace - and the fact that QT has had an active component that is unique to the UK - as a contributing factor to the profound underperformance of long-dated Gilts versus overseas peers since the transition. If the QT pace is maintained at £100bn per year beyond September, and the Bank continues to sell Gilts in equal amounts (measured in original cost terms) across the same maturity buckets, then the Bank's influence on the Gilt curve will grow.

Our base case implies a 10% drop in long Gilt supply

In our base case, gently increasing Gilt sales from the BoE in 2026-27 offset some of the drop in DMO's financing projections. Relative to a scenario of an unchanged QT pace, our base case implies a 10% reduction in long-end Gilt supply in the current fiscal year. Sensitivity to long-end supply/demand is apparent from both BoE and DMO.

Constructive Gilt stance over the summer

Lately, we have turned constructive UK rates, currently favouring receiving 10y10y UK real yields vs. the US (see When exorbitant privilege meets exorbitant need, 14 May) and 30y Gilts on ASW (see Rates-UK section of Deal or no ideal, 2 May):

• Receive the forward real yield between UKTi 2035 and UKTi 2049 against paying the equivalent in TIPS. Entry: 22bp pickup. Target: -40bp. Stop: 50bp. Current: -11bp. Risk: poorly digested long-dated Gilt supply.
• Long 30y Gilt on ASW (using UKT 4.375% 2054). Entry: 91bp. Target: 75bp. Stop: 100bp. Current: 88bp. Risk: re-emergence of UK fiscal worries.

The Bank can make "active" more passive

Our long-held argument that the Bank should let the DMO handle QT still stands: the Bank should sell its desired active portion of Gilt QT each year directly to the DMO, evenly across its portfolio and evenly through the year, at market prices. Giving the Bank a more passive role in active QT in this way would have two clear benefits. Firstly, with only one official seller of Gilts, the DMO can exert a more precise control over the choice of securities in issue and the WAM of the national debt. Secondly, although the Treasury would still have to finance the losses on internal sales within the public sector, the losses would not affect Public Sector Net Debt figures (unless they were re-sold into the market at the large prevailing discounts to par). NZ has done active QT this way.

What if the Bank decides that QT pace should be even slower than £50bn/year?

We have to admit that a sub-£50bn QT pace from October seems unlikely. On the other hand, £50bn does still represent just under 2%/GDP net Gilt supply, so that is a material call on savings on top of the net supply from the DMO.

Try a little thought experiment - ask yourself how much you think long Gilts would rally if the Bank announced that it had changed its mind about the desired future liquidity regime and that QT would cease, forever, with maturing Gilt proceeds being reinvested from now on? We suspect yields would fall by a lot more than the 10-15bp suggested by the Bank for QT's contribution to the Gilt term premium.

That is almost certainly not going to happen. But it is just about conceivable that the Bank decides the QT pace needs to be slowed to, say, £30bn/year - both to slide into the Preferred Minimum Range of Reserves more carefully and/or because such a slowdown is deemed necessary to return QT to "the background" at a time when the Gilt curve is under a degree of stress.

It would require reinvestment. But that should be done very differently now

A sub-£50bn QT pace would require reinvestment and it would not be ideal for the Bank to start "buyback" operations once again after a long period of Gilt sales operations. Besides, the Bank has lately expressed concern about the undesirability of holding duration risk (even though this is indemnified by the Treasury).

The optimal solution, we would argue, would be for the Bank to buy Bills in the weekly auctions following a redemption. But it should buy Bills as "auction add-ons" at the market clearing price. This is, after all, how the US Fed has conducted permanent liquidity injections in normal times. Bills bought by the Bank in this way would, therefore, not interfere with the amount sold to or price paid by private participants in Bill auctions. The DMO would then raise the target Bill stock accordingly and adjust down the rest of its financing Remit for the year. And these Bills would not be sold - they would be rolled at maturity or allowed to run off as required.

Under old EU rules, we suspect this sort of transaction would have counted as a prohibited primary purchase of government debt (although it is standard practice in the US). So the ability to do this would be that rare thing - a "Brexit benefit".

 Rates - AU

 Fade the GDP-led rally in AU front-end rates

 AUD rates rallied and the curve bull steepened this week after GDP printed weaker than BofA's/ consensus expectations. Yields have subsequently rebounded in sympathy with global rates but pricing still remains too rich, in our view. Our economists noted temporary disruptions to due to weather and an unexpected (and likely transitory) fall in public demand offset the impact of higher-than-anticipated private consumption and investment.

Sell Dec '25 futures, buy YM

Stronger consumption and investment figures suggest a cyclical economic upswing remains intact and our economists continue to expect the RBA to leave rates unchanged in July (see Australia Watch: 1Q GDP Review 04 June 2025). We continue to see front-end pricing (<1y) as rich but the belly looks fairly priced. We recommend selling Dec '25 futures and buying 3y bond futures (YM): Entry 21bps, target, 8bps, stop 27bps. Risk: dovish RBA lowers rates in July.

Soft flattening bias into AU futures roll

Australian bond futures will trade reduced tick from the night of Monday 9 June as investors roll from the spot June futures contract, expiring on 16 June, to contracts expiring on 15 September 2025. We see fair value for the YM roll at -1.53bps and XM at +4.21bps. Price action and changes in open interest since last roll suggest a surge in YM longs were quickly unwound in late April. Positioning looks reasonably neutral and the curve has traded in a tight range. We hold a slight near-term flattening bias and recommend rolling early to add duration to portfolios. (see Australia Rates Futures Roll 05 June 2025).

We recommend rolling YM futures early

The 3y bond futures basket contract expiring in Sep '25 will include the 2.75% November 2029 bond line. RBA ownership of the basket will shift to 41% from 42%. The inclusion of this bond means the September YM basket has a higher weighted average maturity (3.32y) than the June YM basket (3.09y). We hold a flattening bias and recommend investors roll early to extend the duration of their portfolio.

  Rates - JP

• We expect MOF to reduce issuance less than bond market expects, cutting 20yr and increasing 2yr issuance.
• We doubt MOF would buy back superlongs until at least Oct-Dec, meaning 10s30s curve could steepen further.

Risk of further JGB curve steepening

Japan's Ministry of Finance (MOF) is to hold a Meeting of JGB Market Special Participants (below, primary dealers' meeting) on 20 June to discuss superlong JGB supply/demand with several major banks and brokerages. The key points at the meeting are to be the potential for MOF to (1) reduce superlong JGB issuance and (2) hold buyback auctions for superlong JGBs. We expect it to reduce issuance for 20yr JGBs and increase it for 2yr JGBs, but do not expect buyback auctions in the near term. If we are right, this would likely drive further steepening of the JGB curve.

10s30s curve could steepen further

Bond market expectations for MOF to cut superlong JGB issuance and hold buyback auctions are rising, and 20yr and 30yr yields fell by respectively 17.2bp and 19.2bp on 27 May, when media reports emerged about MOF's plans to hold a primary dealers' meeting. However, we see upside risk for superlong JGB yields.

In FY16, MOF both reduced JGBi issuance and implemented buybacks. Its initial FY16 JGB issuance plan targeted ¥500bn in JGBi issuance per auction, but it lowered this to ¥400bn in the revised plan it published on 13 September 2016¹. It also bought back around ¥120bn in JGBis during FY16. However, JGBis differ from JGBs in that issuance is relatively small and adjustments to issuance or buybacks can be equally minor.

We would not expect MOF to drastically cut superlong JGB issuance or implement buybacks until Oct-Dec at the earliest given that (1) this is when visibility on FY25 tax revenues will emerge, (2) supplementary budgets are usually drawn up in autumn, and (3) Japan's major elections will be over at that point. Our view implies that the 10s30s JGB yield spread could again widen to above 160bp from late June, versus its present level of around 141bp.

 Rates - CA

•       The BoC struck a dovish tone at this week's meeting but we still expect the BoC to be patient and hold off on a cut at the next meeting
• We recommend clients fade pricing of a July cut by paying July BoC OIS

Dovish BoC meeting but patient on rate cuts

The Bank of Canada held its policy rate unchanged this week while striking a dovish tone in the statement. The BoC continues to balance firmer inflation data and weaker employment and growth data in the context of elevated uncertainty around US tariffs. We expect the effect of the current trade conflict to become clearer in the second half of the year, with the slowdown in activity offsetting the price pressures derived from retaliatory tariffs. At the press conference, Governor Macklem said "underlying inflation could be a bit firmer than we thought", which implies to us that the BoC will be patient in adjusting the policy rate. Outside of tax effects, CPI rose 2.3% in April.

Our economist expects the BoC to remain on hold in July, as it waits for core inflation to trend down, and then cut 3 times heading into year-end at the Sep, Oct, and Dec BoC meetings. Market expectations for a cut at the July BoC meeting is now about 43% priced, which we see as overdone. To fade this view, we recommend paying July BoC OIS in line with our economist's call. We enter the trade at 2.65%, target 2.75%, stop at 2.55%. Risks to this trade are the two inflation prints and two labor market prints between now and the next BoC meeting. While inflation could come down, we expect it will be unlikely that inflation shows a convincing downward trend in such a short period to warrant a July BoC cut.

The BoC made no changes to their balance sheet policy at the latest meeting though we do expect to see the BoC's securities portfolio continue to run down through Sept '25 due to a large maturity on Sep 1. To offset the future decline in settlement balances (Fed reserve balance equivalent), the BoC began offering term repo operations in March. These operations have largely been undersubscribed and so we expect the BoC will begin buying bills, with an announcement at the July BoC meeting, to keep settlement balances from falling too low. Over time, the BoC expects to grow bill holdings in line with the level of settlement balances so that their floating rate assets match the amount of their floating rate liabilities.

  Front end - US

• A Treasury unwilling to grow coupon supply would mean increased reliance on bills.
• We expect to see bills and front-end spreads cheapen after debt limit resolution.

Shorter WAM faces front-end demand challenges

The market has increasingly focused on Treasury WAM shortening as the path of least resistance to support the UST market. We have sympathy for this view but acknowledge it only works until shorter tenor demand is exhausted. In this note we consider scenarios around shorter UST issuance and the extent of front-end demand. We also discuss risks around the front-end supply test to be seen later this year after debt limit increase.

Run up the bills & test demand

A UST that does not account for higher deficits than realized will result in higher bill supply. Our baseline forecasts that stabilize bills as % of marketable debt assume $280bn of coupon growth over four quarters starting in February 2026 (similar to $300bn in four quarters in '23-'24).

If coupon increases do not materialize, bills as a share of marketable debt will continue climbing (Exhibit 21). Under our baseline deficit forecasts, bills exceed 23% of marketable debt in the second half of '26. These are levels last observed in early '21 when UST was growing coupon auction sizes to bring bill share lower. Our baseline forecast for coupon growth sees bills below 23% through FY '27 (Exhibit 22).

Bill demand is strong but may not be unlimited

A Treasury that relies on more bill supply will test demand from front-end investors. Front end bill demand has been strong due to elevated US money market rates, money fund inflows, & recently restricted bill supply due to the debt limit. We expect bill demand will be tested amidst a large surge in bill supply after debt limit resolution. We expect ~$950b bill supply from Aug to Nov '25. The nearly $1tn of bill supply in 2H '25 will challenge the demand willingness of money market investors. To consider the impact on front end investors we look at the recent historic relationship of bills to (1) annual changes in bill supply (2) historic ownership of MMF in USTs. Thoughts on each:

Bill supply swings: historically, large swings in bill supply have seen front end rates cheapen vs OIS; using the post '22 relationship between annual changes in bill supply & 3m bills-OIS would imply a cheapening of front-end USTs of 7bps as the $950b of bill supply hits. MMFs are often willing to increase bill holdings as bills cheapen vs OIS, but they may be limited in capacity.

Historic ownership by MMFs: MMFs have historically owned a max of 46% of total fund AUM in UST bills. These funds currently own 35% in T-bills. If these funds were to return to their max allocation post debt limit resolution, it would imply total bill demand of $950b, in-line with our supply estimates. We believe MMF could potentially absorb all the bill supply but it would crowd out repo.

Bill holdings by investor base: We also looked at available data on T-bill holders as a % of assets across different investor bases using the last 5 years of data. We found that insurance companies and pension funds are already at their max historical capacity, with additional capacity spread out across the remaining investor bases. Overall, the data implies the market has capacity to absorb up to $1.9tn in additional bill supply if they're comfortable bringing bills back up to their prior max allocation. However, we note that some investors are already above their 5y average of bill holdings and this would imply the market has limited capacity to absorb supply without seeing rates cheapen.

Stablecoins could be another marginal source of bill demand

Another potential source of bill demand could come from stablecoins if proposed legislation on stablecoin reserve assets is passed (for detail, see Stablecoins & USTs: demand & disruption). Better regulation on stablecoin reserve assets will likely lead to increased demand for short-dated USTs. Treasury may lean on expected stablecoin demand to justify an increased reliance on bills near term. We expect stablecoin demand to evolve slowly in coming years but do not expect it to be enough to resolve the growing supply and demand imbalance for USTs as deficits continue to rise. We also do not expect this demand to prevent material bill cheapening as supply rises post DL.

Funding pressure post debt limit may require Fed support

In an extreme scenario post debt limit, money markets could see upward pressure akin to what was evidenced in '19. We think the '19 parallel is appropriate given relatively low levels of Fed ON RRP use & a highly uncertain amount of excess reserves with the Fed.

If funding market rates become disorderly or trade above the top end of the target range, the Fed will step in to stabilize money markets. It may well be that UST supply is squeezed hard enough towards shorter-dated issuance tenors such that traditional private sector demand is exhausted & the Fed is required to provide support.

If Treasury relies too much on bill supply, it will cause money market rates to reprice meaningfully. This re-pricing could force the Fed to intervene in money markets (initially vs SRF, eventually via outright bill buying) & provide the ultimate UST market backstop role. Said differently, Treasury may squeeze the UST supply balloon enough to ultimately trigger Fed support; Fed support is likely easier found at the front-end vs long end.

Bottom line:  clients have frequently asked what the official sector can do to support the Treasury market. We think the path of least resistance is for Treasury to shorten issuance, though they may only accept an implicit WAM shortening near term. A Treasury unwilling to grow coupon supply would mean increased reliance on bills. We expect to see bills and front-end spreads cheapen after debt limit resolution. We would not be surprised to see the UST supply balloon squeezed enough at the back end to eventually trigger a backstop from the Fed at the front end.

          Special Topic

• Our forecasts suggest tighter FX-Sofr and xccy bases
• Five themes that support tighter bases are global imbalances, fiscal, de-dollarisation, euro asset rebalancing, and QT

FX-Sofr and xccy: tightening themes

Our forecasts suggest tighter FX-Sofr and xccy bases

Our global rate forecasts imply scope for tighter euro and yen funding vs dollar. In the FX swap market, EGBs and JGBs offer a high rolling FX-hedged pickup over USTs and our forecasts imply this pickup could rise further for EGBs. High pickups could support demand for euro and yen in the FX swap market, tightening the FX-Sofr basis. In the xccy basis market, our forecasts imply US swap spreads to widen vs German swap spreads from current levels to 4Q 2025, especially at the 2y and 10y (Exhibit 23). This may put tightening pressure on the EUR xccy basis, and the associated looser dollar funding conditions could tighten the JPY xccy basis too (Exhibit 24).

Five themes supporting tighter bases

Five structural themes that support our tightening bias in the FX-Sofr and xccy bases are: 1) Europe addressing its saving-investment imbalance means less financial inflows to the US, 2) growing concerns over US fiscal sustainability, 3) potential inflows into euro assets on the de-dollarisation theme, 4) FX hedging needs on global investor rebalancing their euro asset holdings more towards fixed income, 5) divergent QT outlook between the Fed and the ECB.

Two sources of widening pressure

The first source of widening pressure on the FX-Sofr and xccy basis is increased FX hedge ratios by global investors on their US asset holdings. Interest on FX hedge ratios rose after the recent synchronised selloff in US equities, UST, and the USD. The second source is reserve dynamics related to US fiscal policy. Dollar reserves may decline sharply in 2H 2025 post debt limit resolution as the US government rebuilds its TGA.

 Rates Alpha trade recommendations