Rates Spark: Volatile equities make bonds look better

Risk sentiment is set to be the key driver of rates this week and, indeed, the revival of tariff tensions and AI jitters dragged the curve lower on Monday. Although tariff turmoil creates plenty of uncertainty that weighs on sentiment, the potential impact on the broader macro-outlook is more nuanced. So far, US tariffs on the eurozone from ‘Liberation Day’ last year have not thwarted the gradual but persistent growth recovery. A slightly lower rate would benefit the EU but is also unlikely to be a game-changer. The impact on the US economy is possibly larger as a new round of tariff uncertainty does not bode well for investor confidence. And indeed, the bullish move in UST yields was more pronounced.

But the tariff story cannot be seen in isolation from ongoing AI jitters, as these add to fragile risk sentiment. Investors are increasingly selective about the impact of AI on various business models, and we are unlikely to see the end of this anytime soon. In effect, this means volatility in equities can remain elevated for a prolonged period of time. That does beg the question – are bonds then starting to look more attractive on a risk-adjusted basis? And indeed, the 10Y BTP-Bund spread is still hugging lows of around 60bp. European government bonds are traditionally sensitive to equity volatility, but don’t seem that vulnerable this time round, and might even be on the winning side.