We believe there is an attractive opportunity to initiate a long 10yr UK gilt spread against short 10yr German bunds. We believe 10yr UK gilts are pricing in more than realistic fiscal fears as well as very conservative rate cut possibilities. Rising unemployment rate should lower inflation sooner than later and lead to more rate cuts than current market pricing. (Current Terminal rate cut pricing is 3.4% by end CY26 against current BOE policy rate of 4%) We believe that the autumn budget on 26th Nov will show a smaller fiscal hole than previously imagined levels of 20-30 BN GBP. We also believe that the recent deterioration in the labour market points to further downside risk to UK yields, as labour market softness should translate into a stronger foundation for lower inflation in 2026, alongside ongoing disinflationary progress, and an upcoming contractionary budget. Increases in the unemployment rate typically leads to lower yields over time. If the unemployment rate rises above 5.2% in the next three months, the recession threshold in UK will be triggered. Hence our medium-term view on 10yr UK gilts is it is headed towards 4% levels from the current 4.58% levels. On the other hand, German fiscal expansion is a given and we should see increase in supply from CY26 especially in the long end. We also have 1st stage of Dutch pension reforms likely to kick in from end Dec’25 which should further put upwards pressure on long end yields in Eurozone. Hence our view on 10yr German bond yields is it should be soon breaching 3% levels from the current 2.72% levels. Summary: BUY 10 YEAR UK GILTS (CURRENT YIELD 4.58) & SELL 10YR GERMAN BUNDS (CURRENT YIELD 2.72). CURRENT SPREAD: 184 BPS. PROFIT TARGET FOR SPREAD: 100 BPS, STOP LOSS LIMIT FOR SPREAD: 225 BPS Risks to the view: Political instability in UK combined with worse than expected fiscal hole in the budget on 26th Nov.
