Trade Recommendation

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.

Bond investors are doubting the UK government’s fiscal credibility after reports that Chancellor of the Exchequer Rachel Reeves will drop a widely-expected increase in income tax in this month’s budget. 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 as per the Sahm rule. Though our medium-term target is 4% on 10yr UK gilts, for the purpose of this trade, we keep profit target at 2024 lows of 4.2 and the stop loss limit at 4.8 levels where 10yr UK gilts have repeatedly stalled multiple times in the past 2 years. Summary: 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%) Trade Reco: BUY 10 YEAR UK GILTS (CURRENT YIELD 4.58), TP 4.20 & SL 4.80. Risks to the view: The main risks to our view comes from execution risk on the budget and political uncertainty. A perceived lack of credibility on budget measures may see further uptick in yields. A related risk is the inflationary effect of excessive GBP weakening, which throughout 2022-2024 was the link between long-end yield increases and front-end rates volatility: this type of price action is associated with a rise in UK risk premium.

We believe we are entering a time period where the US government shutdown might end soon possibly this week itself. Trump has shown a tendency to make major decisions before crucial holidays. With Thanksgiving on 27th Nov, we believe Trump, Republicans & Democrats don’t want responsibility for a public outcry on travel outages and food stamps availability. Hence the shutdown is nearing it’s end in our view. Meanwhile, the US Supreme Court, in its opening questions, appears to be sceptical about the legality of Trump’s tariff. A deal to end the US government shutdown and a potential rollback of US tariffs by the top court would be positive for risk assets into year-end. This has adverse implications for 10yr UST yields. Especially the Supreme Court judgement on IEEPA tariffs. A rough estimate is around 150 BN USD refund if the IEEPA tariffs are rolled back. This will have adverse impact on US fiscal deficit and term premiums. But what truly shaped our decision was the latest SLOOS data. In absence of official employment data, credit should put true light on the current state of US economy. SLOOS shows the net % of banks reporting stronger demand for C&I loans from large and medium firms turned +ve for the 1st time since Jan this year. Banks, on balance, reported stronger CRE loan demand for nonfarm non-residential properties for the first time since January 2022. Stronger demand for business loans supports the view that business fixed investment will increase going forward, driven by easing of economic uncertainty and new tax cuts. After seeing the latest SLOOS we believe employment might not be the deciding factor for a Dec rate cut. In fact, CPI readings can play a larger role in ensuring that Dec stays a hold rather than a cut. Term premia also remain low relative to fundamentals such as bond supply and inflation risks. Summary: Hence, we now see 10yr UST gradually moving towards the 200 DMA at 4.30 levels from the current 4.09. Summary: SELL 10 YEAR UST (CURRENT YIELD 4.09), TP 4.30 & SL 3.90 Risks to the view: Continued sell off in US equities or exceptionally weak US employment data.

Trade Recommendation: Pay 2-10 US SOFR at current levels of 0.15-0.18. Stop Loss at 0.14 & Take Profit AT 0.25 This week we have a large set of US macro data especially related to employment. May NFP is the most critical data. We expect May NFP to come at 100k against current market consensus of 125k. We also expect the JOLTS for April to come at 7100 lower than the March nos. Even in ISM PMIs for both manufacturing & services, we expect the employment index to come weak. Hence, we expect the short end to remain supported due to weak or sub-par employment nos. But on the other hand, long end US yields might again push up due to fiscal worries, section 899 worries, inflation expectations being high as can be seen in the forthcoming ISM manufacturing & service PMIs. The last week fall in US long end yields was more of a function of month end re-balancing from equities to bonds & index extension. But long end yields might again test the 4.55-4.65 levels on 10yr UST as global investors are shunning US treasuries. Technically, 0.15 level is a significant support on 2-10 US SOFR. Hence we believe the underperformance of long end USTs is a recurrent theme. The month end flattening of the curve is an opportunity to enter into steepeners at the current attractive levels of 0.15-0.18.

We are turning bearish on US long end rates for following reasons: 1) The larger and faster de-escalation in US-China tariffs, which has trimmed the downside tail that we expected would be the potential catalyst to a broader move lower in US yields this year. 2) A later and slower baseline for Fed cuts 3) A still challenging (if less severely so) growth versus inflation trade-off. 4) The broader fiscal trend is the core reason for our bearish view on US yields. The combination of a smaller mechanical tariff headwind and a meaningful reversal in financial conditions from the early-April peak has trimmed the downside risk around growth. The less severe but still unresolved fundamental conflict between below-trend growth and above target inflation, diminished scope for near-term policy rate relief, and broader fiscal trajectory leave in place drivers that can see the reset higher in longer-term yields sustain. We see a nearly $6tn cumulative funding gap between FY26-29, which should necessitate multiple rounds of large-scale increases to coupon auction sizes beginning in February 2026. For all above reasons, we believe we might soon see a buyer’s strike in long end USTs in H2CY25. We expect to revisit the Jan’25 high of 4.85 & possibly 4.95% level of Sep’23. Trade Recommendation: SELL 10 YEAR UST (CURRENT YIELD 4.48), TARGET 4.85 & STOP LOSS 4.18.

Last week’s “what ever it takes” moment announcements from German new Chancellor Merz on breaking the German fiscal debt brakes for increased defense & infrastructure spending might usher in a new rate regime where German bond yields might keep on rising significantly due to higher fiscal deficits. The additional deficit-spending should bring the German budget deficit to 5-6% of GDP initially before the expected growth effects kick in and slowly reduce it back about 4% over the medium term. This implies a steady rise in 10yr German Bund yields to 3.25-3.5% by end CY25. On the UST side of the trade, we believe we are one NFP away from a significant employment shock which might push the Fed to start looking at rate cuts starting from June leading to a total of 3 cuts of 25 bps each in REMCY25. We also believe that the deregulation efforts from the new Trump administration will lead to SLR benefits for UST holdings leading to further increased demand for USTs from G-SIBs. We also see a distinct possibility of QT pause from 1st April (the government shutdown is likely from 14th March) till 30th Sep. This implies a 3.75 level on 10yr UST yields by end CY25. Hence, we are recommending long 10yr UST against short 10yr German Bunds as we expect the current spread at 146 bps to narrow to 50bps by end CY25. Trade Summary: BUY 10YR UST @ 4.30 & SELL 10YR BUNDS @ 2.84 at current spread of 146 bps for a target of 50 bps in the spread. SL at 200 bps spread.