Rates Spark: Inflation is and isn’t the issue
Lead — Recent US inflation data has proved to be muted, yet bond yields remain elevated, highlighting underlying pressures beyond inflation, as detailed in the full note . Higher real yields and an increasing fiscal deficit, particularly for July, indicate a shifting market landscape that institutional traders must navigate carefully. Notably, the fiscal deficit ballooned to USD432 billion, markedly higher than the previous year, which could signal a sustained pressure on rates. As the market watches for signs of how these dynamics play into future rate decisions, focus also turns towards current consensus views amidst these developments.
What the desk is arguing
The prevailing view is that while US CPI reports indicate manageable inflation levels, the significant rise in real yields signals a greater influence on bond pricing dynamics. Per the full note , the benign July CPI report did not elicit significant market reaction, but the mounting fiscal deficit—USD1.8 trillion cumulative—is concerning. This scenario suggests that elevated yields could persist as the market adjusts to these fiscal realities.
The fiscal deficit, projected to surge by approximately USD200 billion compared to the previous year, suggests heightened issuance pressure could impact credit conditions and long-end rates. Such developments reinforce the argument that the bond market is increasingly decoupling from traditional inflationary concerns, focusing instead on the implications of fiscal health on yields.
Where it sits in our coverage
Our consensus target for the USD trajectory sits at 1.075, with ranges guided by major players including: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26) - ubs: 1.12 (Mar26)
The desk’s interpretation aligns closely with jpmorgan's estimates but sits at the higher end compared to bofa, who holds a distinctly more bearish outlook. Given the divergence, now is a critical time for currency traders to reassess existing positions in light of the shifting economic indicators.
How other firms see it
Firms such as jpmorgan and ubs maintain a bullish outlook on USD positioning, while bofa offers a more pessimistic view, suggesting a greater potential for dollar softness ahead. This divergence highlights varying interpretations of how fiscal and real yield dynamics will influence the currency market.
Traders should also keep an eye on the trajectory of US bond yields and the EUR/USD pair, as the respective paths of these currencies are influenced significantly by Fed monetary policy and economic indicators.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01US CPI has been contained, yet bond yields remain elevated, driven largely by real yields.
- 02The July fiscal deficit was a significant USD432 billion, setting a higher trajectory compared to previous years.
- 03Institutional traders must be wary of issuance pressures stemming from rising fiscal deficits.
- 04Current consensus shows a divergence, emphasizing shifting views on USD strength across major firms.
Market implications
Watch for yields when they approach historical averages; a sustained rise beyond 4% could prompt reevaluations of FX positioning. Coupled with ongoing fiscal pressures, USD could strengthen against other currencies, particularly if upcoming data validates this trend.
Risks to this view
A change in inflation expectations or an unexpected shift in monetary policy by the Fed could undermine the desk's current outlook, particularly if fiscal pressures lead to increased market volatility.
Articles Rates Spark: Inflation is and isn’t the issue Published 17:58 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download US consumer price inflation came in tame, yet bond yields end up where they were, or higher. The culprit? Higher real yields.
The US fiscal deficit for July subsequently came in high, adding to the pressure. There's a degree of comfort here at elevated yields, and it's not really all about inflation. That said, the meandering war backdrop is of no help Padhraic Garvey, CFA and Benjamin Schroeder The fiscal deficit for July came in on the high.
The fiscal deficit for fiscal 2026 is running higher than fiscal 2025 US CPI was good (as expected), while the fiscal deficit was bad (also as [we] expected) There was no big market reaction to the benign CPI report for July . Market break-evens have been discounting a benign inflation story for some time now, with break-evens comfortably below the 2.5% printed for core inflation. Still, it was a good number, and better for the front end than the back end on the theory that it takes pressure off the rate hike narrative.
That said, higher real yields were the chief underpinning on the day, and that's in fact been thematic over the past number of months. The thing is, real yields today are not high . They are normal.
Back to where they were pre-GFC. Which suggests they can remain elevated. The US fiscal deficit for July came in at USD432bn – high!
The cumulative fiscal deficit is now running at USD1.8tr. That's some USD170bn higher vs 2025. It's now homing in on coming in some USD200bn higher than for fiscal year 2025.
Not a number that bonds typically get excited by, as for bonds, it's really all about the issuance number and profile. But this does place upside to issuance pressure ahead, which should add some credit pressure to the determination of long-end rates. The deficit had been shielded by tariff income.
Tariff refunds are part of the issue. But the underlying picture is tending to turn net sour also. The overall prognosis here is for the 10yr Treasury yield to trend towards the 4.75% to 5% area.
Going above is not an option that Treasury Secretary Bessent would accept. But getting close is the trade. Count down to the reopening of the SSA primary market The public sector EUR primary market is currently still in its summer break.
Although we are seeing some issuers on the government side maintain their activity, others, like Italy or Spain, have cancelled upcoming bond auctions for August. In the broader EUR-denominated Sovereign, Supranational and Agency (SSA) space, the last benchmark deal dates back to early July, and there has been a drought since mid-July. Last year, it was the German issuers, one Lander issuer followed by KFW, who were first to come out after the summer break around this time of the year – i.e. mid-August.
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