AFS Markets Blog: Midday 03/092026

• Meanwhile in markets, punters put an awful lot of faith in central banks doing the right thing. That’s the message from the ongoing – I am not calling the top here – bond market sell-off that has sent long end yields to the highest level in decades;

• The latest leg higher in long end bond yields, which started in July in the case of US Treasuries and Bunds (Japan is a different kettle of fish as yields have been straight-lining higher this year), has by and large been driven by an increase in real yields;

• Take the 10y Bund, which is at 3.36 percent is up 16bps since mid-July. The 10y real yield, the 10y Bund minus the equivalent inflation-linked swap rate, has risen to 1.09 percent. That’s an increase of more than 20bps since mid-July. If you’re a government with a yawning structural fiscal deficit, such as Germany, the response is: ouch;

• Long-term Eurozone inflation expectations have been rock-steady this summer, with the ubiquitous 5y5y forward inflation-linked swap rate hovering around 2.15 percent. So, perfectly consistent with price stability. At the same time, the long-term ESTR forward rate 5 years ahead has risen to a post-Eurozone crisis high (before ESTR’s introduction in 2019, I use EONIA forwards) of 3.21 percent. That represents a long-term real overnight rate of more than a percent. Which is substantially higher than econometric estimates of Euro Area real neutral rate of zero percent. So, markets expect the ECB to lean against the wind knowing that Euro Area government debt is on an unsustainable upward trajectory with current market interest rates. That makes me wonder: who will Eurozone government leaders pick as President Lagarde’s replacement when she likely quits her job this year? Perhaps a more pliable figure?

• In the US, the increase in nominal yields isn’t a story of higher real yields. Fed Chairman Warsh’s disastrous performance at the July FOMC presser has, for better or worse, kept real yield increases in check. At 2.30 percent, the 10y real UST yield is up about 10bps since mid-July. In nominal terms, the 10y rose by 17bps to 4.77 percent;

• US long-term inflation expectations aren’t as contained either. The 5y5y forward inflation linked-swap rate is at 2.44 percent. While that’s perfectly in line with its historical range, the declines that we witnessed during Warsh’s hawkish honeymoon period after the June FOMC presser have been more than reversed;

• So, do I think Bunds now offer an attractive real yield? Absolutely not. Real yields are still too low, given Germany’s structural fiscal deficit. In the years before the Great Financial Crisis, the 10y real Bund averaged 1.6 percent while Germany’s structural deficit averaged 2.1 percent of GDP. Under Chancellor Merz, the structural deficit has blown out to 3.5 percent of GDP. While I can’t translate a higher structural deficit to a higher real yield, I think the 10y real Bund should at least be a good 50bps higher before I would even consider having a look. And I am not even considering the breakdown of the global order while before 2008 we were still firmly in US hegemony territory. Which, all things equal, calls for higher real yields;

• Turning to some market commentary, around noon Bund and UST yields are down several bps for the day. Keep an eye on OATs as the 10y spread with Bunds remains elevated at a post-Eurozone crisis high of 88bps. I need not mention here that OATs trade like a triple B Euro Area sovereign;

• European equities are higher and up modestly from their recent lows. Which wasn’t even close to correction territory. S&P 500 futures are following suit with equally modest gains. Most AI stocks on our screener of twenty stocks are down this week, though the single digit declines are comparatively moderate – we’ve seen worse;

• Brent crude futures prices at $96 a barrel are basically at the highest level this week, which in turn is the highest level since mid-July. Clearly, the US administration’s campaign of promoting Venezuelan crude hasn’t done much in the way of lowering futures prices. Dutch natgas futures are nearly two percent lower for the day. However, at 72 euros per MWh our ECB overlords will still be nervous enough;

• In currency space the yen is rallying hard. USDJPY is down two and a half points at 156.4. It’s unclear if the leg down is the result of actual intervention, rate checks, or the market spooked by the fear of intervention;

• Looking ahead, eyes will be on Fed Governor Waller’s potentially pivotal speech with regards to the fate of September FOMC. I ask myself, will the real Waller – the hawkish one – stand up today? Pricing for the September FOMC has sagged to 15bps in hikes priced in, down 3bps for the day.

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