Yesterday was another risk-off session, although roller coaster might be a better term. EGBs ended the session with a twist steepener, with Schatz and Bunds posting a 26bp intraday range each. As expected, the H225 segment of money markets is pulling the most weight. While unable to retain the whole gains, German ASW are definitely back in the saddle when it comes to safe-haven status. This resurgence of Schatz and Bund ASW appeal, on mute since the snap elections in France, remains quite tepid given how contained interest rates volatility remains by comparison with its equity counterpart.
While risks of deleveraging flows remain, volatility should start to abate as the rally was rather orderly on the rates side. Our positioning indicators point to a strong addition of long positions, but positioning does not seem stretched, with no visible impact on repo (GC-ESTR and SC-GC unchanged). Finally, the RMSE dispersion of EGB curves around our spline model remained extremely contained. Yesterday’s intraday movement showed that reactions on the other side will be quick in the case of a unilateral walk back on tariff policy, but this remains a very elusive possibility in our view. Fed rate cuts and steep SOFR curve should take time to unwind, not least for a ‘distance to long-term averages’ argument and the Fed dual mandate making it more prone to react to growth concerns. But the limited room for further downside in Europe means current levels of Schatz ASW could correct much faster. On top of this, we see room for the steepening trend to partially revert quicker in EUR IRS than in the USD rates space.
While volatility should subside over the short term, this should put a lasting dent in financial conditions. The uncertain nature of potential tariffs escalation, the multiplicity of involved parties and the improbability of any significant rollback to the initial state of trade barriers should keep constant background noise that will unequivocally keep central banks on the more cautious side, and that includes the ECB. Yet, every day that passes bring the short-term tariff risk / medium-term fiscal impetus closer to balance and lets the impact of past easing percolate further.
