Rates Spark: Back to a 5% 10Y UST on inflation fears
The desk interprets recent trends in UST yields, arguing that the recent rise back to 5% in the 10-year Treasury yields is justified given the hot core CPI data and strong labor market signals. Per the full note, the unexpected uptick in inflation pressures, notably a 0.3% MoM core CPI that suggest annual inflation could surpass 3%, has raised expectations for upcoming Fed rate hikes, particularly as Fed Governor Chris Waller signals support for a 25bp increase in December. In this environment, the desk anticipates continued sensitivity in FX pairs like EUR/USD and GBP/USD, particularly as European monetary policy diverges from the Fed's trajectory.
What the desk is arguing
The desk argues that the recent upward movement in 10Y UST yields to 5% has significant grounding in heightened inflation expectations, primarily driven by an unexpected increase in the core CPI. Per the full note, the CPI's 0.3% MoM increase indicates a worrying inflation outlook that further complicates the Fed's monetary policy considerations.
The data from the past week supports this view, particularly a robust payrolls report that leaves little room for a dovish pivot from the Fed. Specifically, the increase in 10-year yields by 6 basis points since Waller's comments reflects market positioning shifting towards expecting more tightening from the Fed in December.
Where it sits in our coverage
For the current EUR/USD spot at 1.1373, the consensus forecast for December 2026 ranges from 1.1000 to 1.2000, with specific targets from notable firms such as rbc at 1.2000, hsbc at 1.1000, and nomura at 1.2000.
This view aligns with the broader consensus among analysts anticipating a weaker Euro amid a persistent Fed tightening cycle, indicating that the desk's outlook is in line with higher-end targets around 1.1700. Conversely, our published research suggests that broader uncertainties, particularly around energy prices and wages, may temper extreme currency volatility in the near term.
How firms align with this view
Aligned with the desk view
Key takeaways
- 0110Y UST yields have reached 5%, reflecting inflation fears following a hot CPI print.
- 02Market expectations have nearly fully priced in a 25bp rate hike from the Fed in December.
- 03European rates may diverge from the US outlook due to differing economic fundamentals.
- 04Inflation pressures could lead to sustained volatility in key FX pairs such as EUR/USD and GBP/USD.
Market implications
Traders should watch for price reactions in EUR/USD and GBP/USD as the Fed's December meeting approaches, alongside any unexpected shifts in inflation readings. A break above 5% in 10Y UST yields could signal further strengthening in the USD.
Risks to this view
A significant reversal could occur if the upcoming inflation data shows a marked decline or if geopolitical tensions, especially related to energy, lead to a drop in oil prices, subsequently alleviating inflation pressures. Such a scenario would likely prompt market reassessment of Fed rate hike expectations.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
MUFG | Neutral | 1.1200 |
UniCredit | Bullish | 1.1600 |
Rabobank | Bearish | 1.1000 |
Articles Rates Spark: Back to a 5% 10Y UST on inflation fears Published 07:35 Rates Translate Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download US Treasury bonds were quick to sell off as US CPI surprised to the upside. We think EUR and GBP rates should be wary of blindly following US inflation prints, as the economic backdrop differs significantly. We challenge the market's assumption that the ECB and Bank of England should automatically follow a more hawkish Fed Michiel Tukker Impact from hot US inflation was amplified by Fed comments An unpleasant US inflation surprise for rates, taking the 10Y UST yield right back to 5%, is a justified move in our view.
A core CPI reading of 0.3% MoM annualises to a yearly inflation number well above 3% and far from the Fed’s target. Add additional uncertainty from energy prices and AI investments, and markets are right to be nervous. Last week’s solid payrolls report also gives little reason for the Fed to choose a more dovish path for now.
Following on from Fed Governor Chris Waller's comment that he backs a 25bp hike in December and could opt for a 50bp hike, Treasury yields pushed even higher, with the 10yr up 6bp and 2yr up 13bp since before Waller's comments. Markets are now more than fully pricing in a 25bp hike in December, in line with our own forecast, versus 20bp from before Waller's comments. Nonetheless, the hopes of a Middle East de-escalation are pulling energy costs lower, with retail gasoline prices now below $4/gallon for the first time since mid-July.
This will certainly help give a subdued November inflation print, but we won't get that until the day after the December FOMC meeting. The Fed may get a sneak peek, and that should give it the confidence to only raise rates by 25bp. We are not forecasting any further hikes in 2027 as interest rate-sensitive sectors cool further, with housing costs and lower energy prices, amidst weak wage growth, dampening price pressures in the economy.
European rates shouldn't follow hawkish US repricing blindly Euro and sterling rates quickly followed the Fed's hawkish repricing, but we think those moves could fade fast. Interestingly, the 2Y EUR inflation swap fell on the day, suggesting the spillovers were purely in real terms. In other words, markets are quick to translate tighter Fed policy into tighter ECB policy.
But the reality is more complex. Both regions face very different inflation paths, whereby Europe is more exposed to energy prices and the US to AI-related growth. A tight correlation between US and European rates is warranted if driven by oil as the common denominator, but less so if triggered by macro data.
Sources & References
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