Traders are largely sticking with a bet on a flattening eurozone yield curve, despite a painful run that saw 3-month Euribor October 2025 futures close with a 15 basis point loss. This position anticipates a decrease in the spread between short-term and long-term interest rates in the eurozone. The market is currently pricing in just 18 basis points of European Central Bank easing by mid-2025, which suggests that the curve is particularly sensitive to any shift lower in rates. While the direct bid in recent auctions was firmer, hinting at some stability, the overall sentiment still leans towards further ECB rate cuts, with some analysts expecting one more cut in the latter half of the year, though risks are heavily weighted towards the cutting cycle having concluded.
The conviction behind this curve-flattening trade stems from the belief that eurozone inflation will remain well below the 2% target, even with fiscal impulses potentially ramping up in the medium-to-longer term. This expectation continues despite recent geopolitical events, such as renewed hostilities between Iran and the United States in the Strait of Hormuz, which are driving up energy costs and fanning inflation fears across Europe. These tensions have already pushed Germany's 10-year yield to 3.135%, its highest since May 20, and money markets now assign a 90% probability to an ECB rate hike in September, with a significant chance of a third tightening step by year-end.
However, the contrast with the U.S. market is striking. The 10-year U.S. Treasury yield remained relatively stable, rising only 2 basis points to 4.56%, due to America's lower dependence on Gulf energy supplies and cooler-than-expected inflation data. This has led to a dramatic compression in the transatlantic spread, with the gap between German and U.S. 10-year borrowing costs narrowing to 144 basis points, the tightest since early June. This divergence highlights the differing inflation outlooks and central bank policy expectations between the two regions, with the ECB facing a dilemma of tightening to curb energy-driven inflation versus risking economic growth in Europe.
