Update Bonds: Risks for long-maturities
US 10-year yields continued a remarkable decline this month, closing in on 4% and clearly below the 4.3% at the start of this year. (As bond yields decline, bond prices rise.) European yields also fell this month, but by much less. Ten-year Bund yields are considerably higher than the 2.35% at the start of this year.
Most investors expected US yields to rise and European yields to fall this year, but the opposite has happened, and the tables seem to be turning. Pressure is building on the US central bank to start cutting rates next week. Meanwhile, at the European Central Bank (ECB) meeting this week, policymakers confirmed that they are, for now, done with cutting rates, as inflation seems under control.
The ECB is probably more worried about the political and fiscal situation in France, where a new prime minister had to be appointed this week in a desperate effort to produce a politically acceptable budget and to be able to convince Europe and investors that public finances are on a sustainable track.
Markets remained relatively calm, as elections may still be avoided in the near term, but hard choices cannot be avoided for ever. While France has always been too big to fail or to save economically, its crucial role in the nuclear safety of Europe is now adding to its importance for the survival of Europe. Ultimately, the ECB and Europe will have to do ‘whatever it takes’ to save France and the euro, and this includes issuing eurobonds.
Political pressure is building even faster and more directly on the US Federal Reserve than on the ECB. US activity is slowing, while inflation numbers this week were more moderate than feared given the implementation of tariffs. President Donald Trump has stepped up his efforts to gain more control over the central bank, which includes the appointment of several regional Fed governors early next year. The first rate cut will likely come next week, but a more lasting dovish shift in policy is now expected in 2026, in an environment where the independence of the Fed is increasingly questioned.
Central banks may be willing (or forced) to keep rates lower than usual over the next few years, which would anchor yields for short-maturity bonds. However, increasing worries about long-term inflation and government debt sustainability will probably require an increasing risk premium for longer-term bonds. Meanwhile, Dutch pension funds are selling large allocations of very long-maturity bonds as a new pension system is finally rolled out. Yield curves already steepened this year, but there may be much more to come.
