Rates Spark: US PPI and Dutch pension reforms to push curves steeper still

There is only one thing that bonds can do on a surprise 3.7% year-on-year producer price inflation reading, and that is ratchet back up in yield. The initial reaction was not huge, just low single-digit rises across the curve. It seems the market was thinking, its 'just PPI'. A CPI reading like this would garner a much bigger market reaction – especially the July 0.9% month-on-month reading on headline PPI. That said, price action in the hours following the release turned much heavier, and in the end the aggregate reaction was quite considerable, with the 10yr yield up by almost 10bp, and the 2yr yield also well up but not quite as much, leaving the 2/10yr curve steeper. The fact that jobless claims held in at the 225k area also helped push yields up.

Friday will be an interesting test, as our chief international economist James Knightley notes. Headline import prices are currently negative YoY, but this is because of lower energy prices. The core rate is a better metric of whether foreign companies are changing their prices and so far since the tariff announcement import prices levels rose 0.3% MoM in April and were 0% in both May and June. Import prices are expected to rise again in July. The Fed will be paying close attention to this, because if import prices don't start falling soon then that will signal US corporates are fully paying the tariff and then they have the choice of either passing it onto consumers, thus boosting inflation, or absorbing it in profit margins.

In the end, the US 10yr yield is back up in the 4.3% area, and the 2yr is at just below 3.75%; a 55bp 2/10yr curve. At some point, in the coming months, we envisage a 100bp curve. Something like 3.5% on the 2yr to 4.5% on the 10yr could work, with residual upward pressure above 4.5% probable should the inflation jitters really take hold. It can be argued convincingly that these one-off price rises are just that, and hence there is no 'inflation'. But that still needs to be proven, and until then, back end vulnerability remains an issue, despite the rate-cutting theme dominating on the front end.

The very long end of the euro swap curve is seeing increased volatility these days and we believe more is still to come. Volatility measures of EUR rates are mostly following a gradual path lower, but the implied volatility of the 30Y over the coming three months is an outlier and has started picking up again this month.

The recent moves higher in 30Y rates are not just a story about fiscal concerns. The upcoming Dutch pension transition may have played an important role. If increased government issuance would be the key driver, we would expect Bund yields to underperform swaps. We are seeing this behaviour in the US where the fiscal deficit is worrying investors, but in the euro space the 30Y swap spread has remained fairly constant the past months. We therefore see the anticipated Dutch pension funds’ rotation away from longer-dated swaps as a potential driver behind recent moves.

As many large Dutch pension funds prepare for a transition on 1 January 2026, we may see more steepening of the 10s30s swap curve. The 10s30s is already at new records since 2021 but finding the catalysts that push in the opposite direction are difficult to identify. Looking over a longer horizon, a flattening of the 10s30s is usually triggered by the start of a hiking cycle. With the inflation outlook more focused on downside risks, we struggle to see a scenario with a hiking narrative in the near term.