Summary

1. ECB: Easing cycle nears end. The ECB delivered another 25bp cut in June, bringing the deposit rate to 2%, within its estimated neutral range. With inflation near target but growth risks rising, one final cut to 1.75% is likely this year in September before a long pause. Rate hikes may return in late 2026 as fiscal expansion boosts growth and inflation.
2. Fed: Poised to ease as signs of labour market cooling should emerge. The Fed held rates steady in June, balancing political pressure and tariff-driven uncertainty. Policymakers are split, but with softer inflation and labour market signals, we expect 25bp cuts in both September and December, and further easing in 2026, targeting a 3.50% terminal rate.
3. Bond yield targets: We keep our 10-year yield targets over the next 12 months at 2.75% in Germany, 4.20% in the UK, and 4.25% in the US. For now, we remain Positive on core EU, US and UK government bonds, favouring intermediate maturities for both resilience and income.
4. Topic in focus: Gilt turbulence, opportunity amidst the storm. UK government bonds saw sharp yield swings on political and fiscal developments early July. Although political and fiscal risks persist, we expect the Bank of England to cut rates and lower bond yields within the next 12 months. We remain positive about UK government bonds. Also on UK investment grade corporate bonds, which remain resilient, with tight spreads and elevated yields providing a buffer against shocks.
5. Opportunities in Fixed Income: In addition to core eurozone, US and UK government bonds, we are Positive on US Agency Mortgage-Backed Securities, US TIPS, and eurozone and UK investment grade corporate bonds. 

Central Banks

ECB likely to stop cutting soon, Fed likely to start cutting soon 
 

European Central Bank (ECB)

Another cut, nearing Neutral: The ECB delivered a further 25bp cut in June, bringing the deposit rate to 2%. This places the rate within the ECB's estimated neutral range of 1.75%–2.25% and signals that the central bank is close to ending its tightening cycle. From here, policy adjustments will focus on fine-tuning and will be closely tied to incoming data. As the rate approaches neutral, hawkish members of the Governing Council are warning against further easing, given the uncertainty surrounding US tariffs.

Navigating a stronger euro and downside risks: ECB Vice President Guindos stated that the current level of the euro (1.175) is not problematic, though a rapid rise to $1.20 could present challenges for policymakers. We believe risks to economic growth have increased, and inflation will likely remain around target, justifying a final rate cut this year and leading to a terminal rate of 1.75%. After a prolonged pause, we expect interest rate increases in late 2026, driven by fiscal spending that will boost both growth and inflation.

US Federal Reserve (Fed)

The courage to do nothing: At the June FOMC meeting, the Federal Reserve kept its policy rate unchanged, despite intense political pressure from President Trump, who has publicly called for lower rates. Chair Powell made it clear that, were it not for the recent wave of tariffs, the Fed would likely have already begun to ease policy.

Division: Policymakers are split, with half favoring no rate cuts this year due to inflation uncertainty caused by tariffs, while the other half support two rate cuts, perceiving a deterioration in the labour market.

Balancing a conflicted mandate: In recent history, when faced with a conflicting mandate, the Fed has tended to prioritize employment over inflation. Therefore, we continue to anticipate rate cuts of 25bp in September and December, followed by two further cuts in 2026. This would bring the terminal rate to 3.5% by mid-2026, compared with market pricing indicating a terminal rate of 3.24% in Q3 2026.

Bond Yields 

Mixed

US yields have fallen from recent highs as markets reassess the direction of monetary policy. Softer inflation data, signs of a cooling labour market, and pressure from the US President have increased expectations of Fed rate cuts this year, pushing down both US short- and long-term yields.

In contrast, German yields increased in June due to fiscal developments and NATO spending commitments, despite the widely expected eighth consecutive rate cut by the ECB.

In the first part of the year, bond yields were driven by tariffs and fiscal risks. In the second half of the year, the focus should shift back to fundamentals such as growth, inflation, and global demand. US yields may come under pressure in the coming months as the US government must refinance USD 7 trillion of debt before year-end. We anticipate the US 10-year yield will then decline to 4.25% by mid-2026. We expect German yields to remain within a certain range before beginning to rise in 2026, to 2.75% by mid-2026, driven by higher growth, inflation, and significant bond issuance. 

Topic in Focus

Gilt turbulence: Opportunity amidst the storm

A volatile summer for UK yields: The UK government bond market has experienced significant volatility. On 2 July, 10-year gilt yields posted their sharpest rise since the Truss mini-budget crisis of 2022, driven by political uncertainty and fiscal concerns. Tensions over contentious welfare reform within Labour added to the pressure. Although the reform passed, significant concessions reduced the projected £5 billion in savings. While this does not meaningfully alter the UK fiscal outlook, it reinforces concerns about the credibility of planned spending cuts.

Political risk and fiscal discipline: Markets are increasingly alert to signs of weakening fiscal discipline. The government's U-turns on welfare and internal divisions have fueled fears of further slippage. While PM Starmer's reassurance that Reeves remains in post has calmed markets slightly, the shift in sentiment is clear. Investors now want more than just pledges; they are demanding credible and detailed plans to rebuild fiscal headroom. We believe tax rises are the most likely option. Major spending cuts appear politically challenging, particularly as other spending needs, such as defense, are rising. Furthermore, loosening fiscal rules could undermine investor confidence.

Market positioning: Despite volatility, UK gilts offer a yield premium over their European counterparts, with 10-year yields well above Bunds (see chart). We expect the UK 10-year yield to fall to 4.2% within 12 months. With the BoE likely to cut rates - we expect quarterly rate cuts from August until the policy rate reaches 3.50% -, economic growth to slow, inflation to decline, and a higher likelihood of a Quantitative Tightening slowdown, current levels offer a compelling entry point for long-term investors. Volatility may persist ahead of the autumn budget, but gilts remain attractive in our view.

Corporate bonds: We prefer quality. The investment grade corporate bond market has held up well, with tight spreads and elevated yields. Although fundamentals have softened slightly, all-in yields (see chart) provide a buffer against shocks.