BUY 10YR UST AGAINST SELL 10YR BUNDS

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.

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