Global Rates: European Rate Markets – looking ahead over 2H26

Hi, and welcome to At Any Rate, JPMorgan's global research podcast, where we take a look at some of the drivers behind the biggest trends and themes across fixed income currencies and commodity markets. I'm Francis Diamond, Head of European Rate Strategy at JPMorgan, and today I'm joined by my colleagues, Kigendre Gupta and Aditya Chaudhary to discuss our thoughts on European rate markets over the second half of this year. So to state the obvious, the Middle East conflict has dominated European rate markets over the past few months, and I think going forward, we still expect this to be one of the main drivers as we look ahead into the second half.

Latest news reports of a MOU on the deal between Iran and US maybe have given a little bit of optimism to markets, but I think in our sense, the medium-term outlook for the Middle East conflict still remains uncertain. And despite the recent fall in Brent oil prices, there is still an indirect impact of energy shock that will persist and impact both UK and European inflation dynamics over the coming months. If we look at market performance this year, front-end rates, so 1-year, 1-year SONIA and 1-year, 1-year ESTA yields are 75 basis points and 45 basis points higher respectively, as markets continue to expect some degree of monetary policy tightening.

So let's start with the ECB, Kigendre, who have hiked policy rates 25 basis points this week as expected and presented baseline energy scenarios that imply a total of four hikes given more elevated and sticky core inflation projections. So how did you read delivery? What do you think of current market pricing and has the ECB dampened rate market volatility for now?

Thanks, Francis. Now, if the ECB's goal at the press conference was to keep market pricing largely stable, then precedent card was triumphant in that regard. ESTA yields remain broadly unchanged during the conference, whereas volatility dropped like 0.2, 0.3 basis points per day.

Now, of course, yield rallied towards the end of the day, but that was due to the positive headlines around Middle East and not on ECB. So the delivery was largely consistent with recent ones where volatility remains muted as the ECB sticks to its data-dependent meeting-by-meeting approach. As I mentioned, post the positive headlines around the Middle East, yields rallied a lot and ESTA curve is now pricing around, give or take, seven basis point for June, 24 basis point for SEP, and 38 basis point of hikes for the December meetings.

And with the peak of the ESTA curve pricing around 43 basis point of further hike from the ECB. I think these levels are broadly fair and believe that ECB pricing will remain in relatively modest ranges. The ECB didn't appear, in my view, to be concerned too far behind the curve, and thus we believe that future hikes will likely be measured and well telegraphed.

In my view, I think the tail risk of significantly higher rates have shrunk, which should cap volatility as well. Okay. So front-end looks broadly fair.

I mean, Aditya, if we go further out the curve, you've been highlighting this range trading environment for 10-year bunds based on various Middle East conflict scenarios. Does anything there change over the next couple of months? If we look cross-market, do you see any opportunities?

Sure, Francis. So the title of my piece is range bound. So I think we will, my expectation is that most of the Euro yields will remain stuck in tight ranges, but overall, over the second half of 2026, I retain our strategic bullish duration bias, both on the 10-year Germany, both outright and cross-market versus US.

But also it's driven on the combination of several factors, like one, the ongoing uncertainty around the US-Iran conflict and the status of the Strait of Hormuz is likely to keep macro and policy out of volatile and directionally unclear, and that would be driving the range, the bund yields within those ranges. And on the ECB, like after yesterday's meeting, I can still believe they will deliver one more hike in September of 25 basis point. But given the hawkish forecast they presented, I think now the risk queue has moved more than delivering more of chances with three hikes instead of stopping at one.

So two still remains a strong base case, but with a risk of three, and the market price is almost there. So not a big market move there. Ongoing strong investor demand for EGBs, mainly coming from non-domestics.

We published our global activity chart back today, and if you look at the data from the first quarter, the demand for Euro Govies was quite strong coming from international investors, and also some domestic investors like banks. And I think that is pushing on term premium not being a Euro narrative we have been running for a while. And then lastly, the fiscal response to cushion against rising energy prices will likely be limited, which has been the case so far.

So given all these factors, I still believe 10-year German yields will remain range bound. And when we do our Middle East conflict scenario analysis, we found that 10-year German yields should be moving somewhere between 285 to 315 range in majority of scenarios. And over the near term, what we have been doing, and we continue to prefer doing the same, like trading that range tactically.

But at the same time, what we have been stressing, and I think that remains my high conviction view, is that intermediate yields on the German curve are pretty much across the EGB spectrum, are quite compelling for long-term investors who can tolerate the near-term volatility of these range moves. Like what we have been saying is 10-year German yields trading around 3% is quite attractive. As the risk of a large sustained sell-off above 3% is quite limited, even in the extreme scenarios, given our view, as I mentioned above, that fiscal term premium is not a German or a Euro story.

And also, if let's say there is a material repricing higher of ECB tightening expectations if we move pricing closer to more than three hikes cumulative, in that world, I would expect a bit more bare flattening of money market curves, which will again keep intermediate level of yields much more anchored and range-bound. So overall, I think locking in at 3% is a good medium-term stance in our view. And finally, as you also highlighted, like cross-market, we have a strategic overweight Germany versus US bias, especially in the intermediate sectors, given our bullish duration stance on Euro.

The valuations are also attractive when adjusting for money market pricing between US and Euro. And finally, even our US colleagues have shifted to a more bearish view on US duration in recent weeks. So all these add up to a strategic overweight Germany versus US yield bias.

Okay. So that's pretty clear. I mean, if we then focus on intra-MU spreads, I mean, that's tied into ranges, so I'm pretty sticky at these sorts of levels.

Do you think this dynamic continues over the next few months, or do you think there's any potential for idiosyncratic widening as 2027 elections in some of the bigger countries start to come onto the radar? Yeah. So on intra-MU and EURUSSS spreads, like our strategy has been quite unchanged for pretty much even before the Middle East, the geopolitical escalations we have seen since March.

And that has been that the risk reward is not attractive in spreads at current levels. And we continue to retain a cautious stance given the heightened uncertainty around Middle East and the Strait of Hormuz. Valuations as I mentioned are not cheap, the carry is quite limited.

And also the positioning is still overweight. So all these factors doesn't give me much excitement about owning carry in the space. What we are highlighting in our media outlook is that we plan to trade French spreads tactically after the summer, because we believe that the focus will shift towards the presidential election news flow and polling.

And in my base case, I would expect any France-Germany spread to somewhere trade between 70 to 85 basis point range. We are currently around 75 basis points. So I think the bias will be trade from the lower end of the range to be short.

And similarly, we plan to trade Italian spreads tactically around potential political noise linked to 2027 budget negotiations. Because I can see some coalition frictions happening, given that the recovery fund is ending at the end of 2026. And also they have to do some more higher defense spending.

So budget negotiation could create some noise. And in that world also, I can see 1080 Germany spread trading in a 10 to 15 basis point range on those noises. So again, trying to capture that tactically would be one of the strategies we would be aiming in the second half of this year.

And lastly, if I have to pick some of my favorite overview picks, I would say Spain and Greece in intra-EU and EU in SSA space are my favorite picks. Let me jump in here and then maybe switch the focus to Francis. So Francis, you know, the Bank of England meets next week and market expectations are firmly for them to keep rates on hold.

How do you see that tone evolving around the policy stance? And in terms of 10 years, what's your view for the second half of this year? Yeah.

So as you say, there's very little price for next week. Meetings on the 18th of June and we fully expect the Bank of England will keep rates on hold at 375. But I do think there will be some descent.

So we have a 7-2 vote split with probably MPC members pilling green, dissenting for a rate hike, particularly given some of the commentary from both of them around the impact of supply shocks and the impact on inflation expectations and wage formation processes. Possibly we may see a third hawkish descent. Maybe Ramsden or Mann also voting for a hike, but there's not been a huge amount of commentary from either of those two members recently.

So I think the tone will kind of give you a sense that there is a sort of hawkish bias. I don't think MPC in general messaging will push back much on the market pricing where we've got about 40 basis points of hikes priced by the end of this year. But also at the same time, I don't think there'll be much visibility in terms of the timing of any potential rate moves.

So I think given where we are in terms of market pricing, I think there's a limited ability for the BOE to really give a hugely dovish message here, even if there is some evolution or sort of potential change in the Middle East outlook, purely because indirect effects will linger. And even if MOU is agreed in the coming days, the impact of the increase in energy prices that we've seen already, indirect effects on consumers will persist, and probably some of the market optimism in terms of the recent rally we've seen in front-end yields in the last day or so on the longer-term solution to the conflict looks a bit overdone. So our base case is for a 25 basis point hike in July.

As we go further out the curve, I think it's similar to how we discussed with Aditya the view on bunds, to be honest. I think 10-year yield is still very much range-bound, bounded by our Middle East scenarios. We have nudged our end-of-year 4Q26 yield forecast for 10-year gilt a little bit higher to sort of around about 480, so only a few base points below where we are now.

And we remain roughly sort of neutral in terms of market views here, given yields are somewhat 10 basis points below our kind of ongoing straight-up-hormuz-limbo scenario for the conflict, and still some 35 basis points below our kind of high-end energy shock scenario projections. Okay, I guess the other point is that domestic politics remains in focus as the Makersfield by-election approaches against the backdrop of two ministerial resignations this week. So how do you think political temperament can impact the curve and soft spreads?

Yeah, so the election is drawing closer. It's the same day as the Bank of England, and yeah, I think there is just increased pressure again on Prime Minister Starmer. As we saw a resignation at first of Defence Secretary John Healey this week, and then a few hours later, one of the junior defence ministers also resigned.

So I think this does mean focus on the by-election and the subsequent sort of bill over effects in terms of a Labour leadership contest is still very much there. As we highlighted in the last publication, when you look at the opinion polls, there have only been two at the time of recording, still show a pretty decent lead for Burnham ahead of reform. And there's also a sense when you look at the sort of parliamentary voting intention of voters in Makersfield that sort of Burnham as a Labour candidate kind of gives a general 15% boost for Labour if you were to kind of roll forward those opinion polls into an overall parliamentary vote.

So if we assume Burnham wins by-election, I think it's quite reasonable to expect there'll be some formal Labour leadership challenge launch in subsequent weeks, and possibly the larger the margin of victory, maybe if we're talking about sort of a winner, let's say more than 5,000 voters sort of majority above reform, then possibly the sooner we'll see an announcement from Burnham on his leadership challenge. I think given we have seen just more pressure with these resignations you mentioned this week, it is also possible that even though Starmer has said he would fight any potential leadership contest, possibly he could just concede very quickly if Burnham is the only challenger. But I do think if other challenges appear alongside Burnham, then probably a leadership contest is going to take a whirl through the summer and possibly a late summer, early autumn before we get any clarity around the result.

And then in terms of markets, I mean, I think probably if Burnham wins, there's a very limited guilt market reaction. And I think if you were to see any, let's say, knee-jerk steepening in the curve post the by-election, I think in our view that's probably a bit of a fade. Given I just don't think we're in any position at this stage to consider fiscal implications of a Burnham winning the by-election without getting closer to a budget later this year, I don't think we can really draw much conclusions around how fiscal policy could evolve.

At any event, if there were one of surprise reform victory, possibly we see a little bit of flattening of the 2's-10's guilt curve. I think going forward as you look through the second half of this year, if we do have Burnham as Prime Minister at some point following a potential leadership contest, then I do think at some stage maybe the focus might need to shift in terms of the fiscal outlook in his kind of potential government in terms of possibly increased investment spending, try to shift the focus a bit more in terms of a more positive growth narrative. I think our sense is we get closer to a budget in the autumn, maybe that's September, maybe that's October, difficult to know at this stage.

I would expect there to be some increased risk premium priced into both the sterling curve, so probably a steeper 2's-10's guilt curve and narrower 10-year swap spreads. However, I think for now it's just too early to position for this given we are continuing to see the ongoing sort of market impacts of Middle East conflict and the evolving sort of potential for deal or some form of resolution is still the main driver of UK curve at this stage. So Kigendre, let's end with a few thoughts on ScandiRate markets.

So for Sweden and Norway, how do you see central banks acting over the rest of this year? And are markets priced in line with your views? I think both Riksbank and Nordisk Bank will stay on hold next week, but we do see them hiking in September in our baseline scenario.

We expect both of them to deliver just one 25 basis point hike, but acknowledge that risks are biased towards maybe more hikes after that. I highlight that currently core inflation in Sweden is low, so CPI-8 is around 0.5%, but that includes a 0.9% impact of VAT cut that was put into effect from April 1st. Headline inflation is already at 1.5%, so accounting for the VAT adjustment, it is above the 2% target with risk of this rising over the coming months.

I think Riksbank will likely deliver a hawkish message next week, taking up a hike over the next few months. On this, I also mentioned that the ECB rate hike this week and indication to hike further will also play a role in Riksbank's reaction function. So yes, one hike in baseline with potential for more over the rest of the year or early next year.

The Nordisk Bank will find it hard to not deliver a hawkish message in my view, even though they stay on hold after delivering a surprise hike last month. The underlying inflation backdrop in Norway remains strong, with core around 3.4% in May and expected to hover around 3% over the coming months. I expect them to also raise their guidance for neutral rates higher next week, with the upper end lifted towards the 4% mark from currently at the 3.5% mark.

This is nominal rates. Now I think this should lead to some steepening of the money market curve in the second half of 2027 and beyond. That sector should steepen based on the rising of neutral rates.

On market pricing, I believe they are broadly fair against our baseline. But like, as I mentioned, I do see risk of some underperformance versus a rival over the coming months, mainly because the amount of hawkishness I expect from the central banks to display is probably just about fair in my view. Okay, thank you for that, Kagendra.

Thank you, Aditya, as well. That's all from us. Thank you for listening and stay tuned for more updates on fixed income space here on At Any Rates, JPMorgan's global research podcast series.

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All Rights Reserved. This episode was recorded on the 12th of June 2026. For more information, visit jpmorgan.com.