Rates Spark: The fiscal number can eclipse CPI
The transition to higher U.S. yields is becoming increasingly influenced by the deteriorating fiscal deficit, which could overshadow the consumer price index (CPI) readings. As highlighted in the full note, concerns over the fiscal deficit are intensifying, with the forthcoming CPI expected to show a core rate of 2.5% year-on-year, which many in the market view as manageable. However, with market break-evens currently under 2.5%, the focus may pivot towards how the fiscal landscape could impact the supply of bonds. This scenario underscores the importance of understanding fiscal shifts in the context of Fed policy and bond market reaction as we progress through the second half of 2026.
What the desk is arguing
The deterioration of the fiscal deficit could have a more pronounced impact on bond supply than the upcoming U.S. CPI numbers. Per the full note, although the CPI inflation print is critical, the market's current relaxed stance indicates that it is the fiscal implications that could dictate yields moving forward. With expectations of a core CPI of 2.5%, the emphasis on fiscal health may start to overshadow inflation fears in bond markets.
The desk draws attention to the relationship between fiscal policy and bond yields, emphasizing that a looser fiscal stance could lead to an increased supply of bonds, thus pressuring yields higher. With break-evens running in the 2.25% range, this indicates that any significant fiscal news could lead to quicker adjustments in yield expectations.
Where it sits in our coverage
For the EUR/USD pair, our consensus target stands at 1.1700 with a range of 1.1200 to 1.2000 for March 2026. Notable firm targets include rabobank at 1.1759, jpmorgan at 1.1800, and investec at 1.1455.
This view indicates a divergence from the consensus, particularly as some firms like citi hold a lower target of 1.1300, signaling broader market skepticism about the euro’s strength relative to fiscal developments in the U.S.
How other firms see it
Firms aligned with expecting stronger EUR/USD movements include rabobank and morganstanley, while those with a more cautious outlook, such as citi and bofa, suggest a more bearish approach.
The impact of U.S. fiscal policies may also enhance volatility in related pairs such as GBP/USD and USD/JPY, with shifts in expectations likely reverberating throughout the FX market.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Higher U.S. yields may be increasingly driven by fiscal deficit concerns rather than traditional inflation metrics.
- 02Upcoming U.S. CPI is anticipated at 2.5%, while market break-evens remain below this level, indicating a relaxed market stance on inflation.
- 03Emerging fiscal implications could dominate bond market narratives, potentially pressuring yields higher.
- 04Consensus targets for EUR/USD range from 1.1200 to 1.2000 for March 2026, highlighting divergent views among firms.
Market implications
Watch for yield movements on U.S. Treasuries as fiscal data emerges, potentially shifting sentiment in the FX market. Key levels to monitor include the 2.5% break-even inflation rate as a threshold for further directional moves in bonds and consequent FX reactions.
Risks to this view
A sudden and unexpected uptick in inflation readings or a fiscal policy announcement that showcases a significant bond supply increase could undermine the desk's positioning on yields and the resulting currency impacts. Additionally, geopolitical events could shift focus away from fiscal narratives.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
Commerzbank | Bullish | 1.2200 |
UBS | Bullish | 1.2000 |
Citi | Bearish | 1.1000 |
Articles Rates Spark: The fiscal number can eclipse CPI Published 15:04 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download While the transition to higher US yields is linked with the war and higher energy prices, in fact the market discount for inflation is quite relaxed. The July reading is expected to see core at 2.5% YoY. Break-evens are already below this, paving an auspicious path ahead.
The fiscal deficit, though, has been morphing in a more bond negative direction Padhraic Garvey, CFA The US CPI number for July will get the headlines, but more focus should be placed on the fiscal deficit deterioration US CPI inflation is crucial, but the market is already quite relaxed on it We get updates on the two most important fundamental drivers of US Treasuries on Wednesday, namely US inflation and the fiscal deficit. The former impacts the real return attainable from bonds, while the latter helps determine the supply of bonds. Arguably, nothing else should matter, and if they do, it's only to the extent that they ultimately impact inflation and the supply of bonds.
Recently, the bigger attention has been more on the former than the latter, as upward pressure on energy prices in addition to prior tariff price hikes saw inflation print uncomfortably high. To the extent that these impulses have maxed out, there is a path ahead for easing in inflation as we progress through the remainder of 2026. That stems from the crucial assumption that the oil price remains contained, through an ultimate reopening of the Strait of Hormuz (in the coming weeks).
The core number anticipated for July at 2.5% year-on-year is absolutely fine, and should act as a rate that headline inflation (now at 3.5%) should trek towards as we progress through 2026. Better still, market break-even inflation rates are running at comfortably below 2.5% (actually in the 2.25% area). In fact, the market is already discounting a mild inflation landing.
It's the higher real rate component that's driven the 10yr Treasury yield higher in recent months, not inflation break-evens. Treasuries have not been worrying much on the deficit, but should start to pay more attention It's also true that the recent rise in the 10yr Treasury yield has not come from a deterioration in credit perception, in the sense that it's not directly linked with any delta in the deficit. We note that, as the 10yr swap spread has managed to hold broadly steady in the 40bp area since May.
That 40bp spread is, in effect, the additional rate that Treasury Secretary Bessent needs to pay over and above the risk-free-rate (SOFR), as compensation for the elevation in the fiscal deficit (6% of GDP area). Why has it been steady? Well, the good news is the US fiscal numbers have not deteriorated since fiscal year 2024.
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