Rates Spark: Domestic drivers more important than US spillovers

US payrolls pushed US Treasury yields significantly higher, but the spillovers to EUR and GBP rates were remarkably muted. Gilt and Bund yields rose initially on the data release, but were also quick to retrace that increase and actually ended the day lower than the open. We have observed the correlation between USD rates and other markets decline since the presidential elections in 2024, but rarely do we see days when rates move in opposite directions.

Gilt yields are usually a lot more sensitive to US rate moves – but in the UK, domestic stories are growing more dominant. A political risk premium is likely to continue driving Gilts in the foreseeable future as Labour’s poor polling calls for a change in direction. But sterling markets are also seeing an increasingly high chance of another Bank of England cut in March, even though the latest US payrolls data has pushed the next Federal Reserve cut to June or July. This morning's weak monthly UK GDP data from December supports a more dovish turn from the Bank of England. The diverging narratives between the US and UK may therefore allow Gilt yields to ease lower despite the upward pressure on UST yields.

Today, we have EU leaders meeting in Brussels to further discuss, among other things, defence with NATO representatives. We'll be listening for hints about potential future joint debt issuance. Yesterday, the EU parliament did vote in favour of a €90bn loan to Ukraine, which would be funded jointly. Having said that, at this stage we doubt more will be promised despite calls from, for example, French President Emmanuel Macron earlier this week to increase joint debt. Instead, this discussion is probably more important from a structural perspective on the EU's role in broader economic investments. So far, not everyone is enthusiastic, however, and we might find some opposition from countries like Germany.

Meanwhile, investors continue to like EU bonds, with another heavily oversubscribed order book for the dual tranche EU deal on Tuesday. Spreads for EU bonds in the 10y area are just below 30bp, placing them wider than Germany but also notably tighter than France, for instance. The EU has an AAA rating, which makes the bonds part of a fairly exclusive selection of highest-quality assets when assessed at a global level. Together with Germany, the EU is one of the largest issuers globally for AAA-rated debt.