Rates Spark: The evaporation of real yields

What the desk is arguing

ING argues that the gradual upward drift in bond yields is above all a story of inflation re-pricing, not of growth optimism. The evaporation of real yields is the key mechanism: nominal yields rise only modestly while inflation expectations advance, compressing real returns. This is an uncomfortable backdrop for fixed-income investors, as it implies central banks are falling behind the curve.

The desk sees the risk that the measured pace becomes disorderly, particularly if the Strait of Hormuz supply disruption persists. Higher economy-wide prices would then feed through to core inflation, forcing central banks to abandon their dovish bias. In that scenario, the current gradual bear-steepening would accelerate into a sharp sell-off in the long end.

Where it sits in our coverage

Our consensus view aligns with ING’s structural bearishness on real yields, but we see the pace as more restrained absent a major supply shock. Our 1.075 fair-value estimate for EUR/USD incorporates a modest real yield differential in favor of the dollar, which could widen further if US inflation expectations rise faster than in the euro area.

However, we emphasize that the inflation channel is not our base case for a material EUR/USD break. The key firms in our coverage are largely aligned: JPMorgan targets 1.10 by March 2026 and Goldman Sachs sees 1.08 by December 2026, both consistent with moderate real yield compression. Morgan Stanley is more bearish on EUR/USD at 1.04 by March 2026, partly on the view that US real yields will hold firm relative to Europe.

How other firms see it

JPMorgan is aligned with ING’s inflation risk view but expects a more orderly adjustment, citing central bank credibility to keep the process measured. Goldman Sachs is broadly aligned, seeing the evaporation of real yields as a transitory phenomenon that reverses once supply disruption abates.

Morgan Stanley is contrary: they argue the rise in breakevens is already overbought and that real yields will snap back as central banks hike more than priced, causing a sharp flattening rather than bear-steepening. This would challenge ING’s core assumption of persistent real yield erosion.