Once again, a flurry of geopolitical headlines has failed to upset rate markets in any major way, and yet we do think a more bullish mood could stick. Before this weekend, equity markets hit new highs, and risk indicators like the VIX also pointed to very strong sentiment. This optimism helped euro rates higher over the past months, including the pricing out of possible European Central Bank rate cuts. Now that uncertainty is returning to markets, we do think slightly lower rates are justified in the near term.
But the reaction from rates may remain moderate as markets are now better aware of the likely moderate economic impact from tariffs. Since ‘Liberation Day’ last April, the eurozone’s growth outlook has continued to improve, and economic data has consistently managed to beat expectations. Meanwhile, the stock market seems more focused on NVIDIA’s profitability than a potential break in transatlantic relations.
Having said that, we’re still dealing with significant known unknowns, such as the possible escalation paths going forward. Both the US and the EU have the ability to inflict significant economic damage on each other outside trade tariffs. But a mere 1.6% drop in the euro STOXX index on Monday still suggests markets are expecting a de-escalation. Which raises concerns about complacency. From this perspective, one could argue that safe assets like 10Y Bunds should see yields come down further.