Rates Spark: Central banks are just as wise as the rest

The Bank of England kept rates on hold yesterday, with a voting split of six for a hold and three for a 25bp cut – a mildly dovish surprise. But as with the outcome for the Federal Reserve, the market impact from the decision was limited, with central banks just as wise as the rest of the market when it comes to the political and geopolitical uncertainties ahead. It will take an actual change in the data or significant news on trade or geopolitics to take us out of current trading ranges.

As for the situation in the Middle East, the headlines continue to dominate, and oil prices have kept inching higher. Short-dated inflation swaps have continued to rise; the 2y EUR inflation swap has risen from 1.5% to over 1.8% in June. But this hasn't really dented the market expectation for one more cut from the European Central Bank.

The wider impact is visible, though relatively muted. Risk assets have been on the back foot again over the past sessions, and common “fear indicators” like the VIX are also somewhat higher. Bund swap spreads have only seen a modest further outperformance of the safe asset as the 10y now yields 3.5bp below swaps. Implied rate volatility has already nudged back from its initial modest increase.

In eurozone government bonds, we have witnessed some rewidening, but some also on the back of headlines more related to domestic issues, like in France, for instance. But France aside, spreads generally remain at historically tight levels, with a 10y spread of Italian government bonds over Bunds still below 100bp – though coming from as low as 90bp earlier this month. The appetite for aggressive tightening positions at such levels will be limited going into a typically less liquid and more volatile summer period, especially considering the uncertainties around geopolitics and trade relations with key dates still coming up.

The latest data shows that Dutch pension funds continued to add interest rate hedges in the first quarter of 2025. As funds are preparing to transition on 1 January 2026 or 2027, we expect them to stabilise their funding ratios through interest rate risk hedges. Upon transitioning, however, we expect a significant unwind of longer-dated hedges.

The two largest pensions, ABP and PFZW, with assets totalling around €800bn, still have relatively low interest coverage ratios. If these funds decide to follow the upward trend to protect their funding ratios, we can still expect strong demand for fixed receivers going forward. Given the new system sees less use for longer-dated (30Y+) hedges, the focus will likely be on relatively shorter tenors.