Energy prices climbed, inflation jitters followed, and bonds took another leg lower. Traders ramped up expectations for aggressive tightening by the Bank of England and the European Central Bank, and yield curves flattened in response. One benchmark to watch - the spread between 5 and 30 year sovereign yields - has been compressing for weeks. In Germany and the UK, the 5s30s is now the narrowest since early 2025, and in the US it is heading for a sixth straight weekly decline, even as the 30 year Treasury yield hit its highest level since 2004 on Thursday.
Plenty of pros are keeping maturities short. Lauren Van Biljon, a senior portfolio manager at Allspring, said, "Pricing on interest rates looks too hawkish." She is holding an overweight in two to five year UK and European government bonds. "The very long-end of curves in both US and Europe remain a tough buy, but there are opportunities in short and intermediate bonds that are interesting."
CG Asset Management's Emma Moriarty is skeptical about the pace and scale of BOE tightening implied by markets. The firm has been buying one to five year gilts, arguing that the market's path is hard to reconcile with the UK's weak growth outlook. Sharing that stance, RBC BlueBay has put on a UK steepener designed to benefit if longer-dated bonds cheapen versus the front end.
Mike Bell, who oversees market strategy for the firm, argued that markets have gone too far in factoring in four BOE hikes. "We're monitoring oil prices carefully in case we need to change our minds," he added. "But we think that the Bank of England is unlikely to hike as much as is priced in."
At Fidelity International, Mike Riddell, who leads the firm's Strategic Bond Fund, cut exposure to longer-dated debt across several areas, including the UK and Italy. In a Tuesday note he wrote, "We still believe markets are pricing too many hikes across several developed economies, however we now prefer to express this view toward the front end of the curve, through yield-curve steepeners."
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Steepeners have been a bruising trade lately, so few want to jump the gun on a reversal. "Many people have been caught on the wrong side of the trade and so there will be I think a reluctance to re-enter too soon," said Camille de Courcel, who heads developed-markets rates strategy for BNP Paribas SA. She said that with energy prices hovering near the ECB's severe scenario, a 3.5% terminal rate "cannot be ruled out."
Positioning still skews hawkish. Interest-rate swaps now imply four additional 0.25-point ECB increases before next year ends, marking the most hawkish setup following the central bank's second rate increase earlier this month. In the BOE's case, traders have fully priced in four hikes and see a strong probability of a fifth.
ING rates strategist Michiel Tukker agrees steepeners are ultimately the right direction, but he is waiting for oil to settle down before leaning back in. "This is something the entire market struggles with," he said.
The theme is consistent: stay closer to the front of the curve. Managers are favoring two to five year and one to five year government paper or expressing views with yield curve steepeners rather than loading up on very long duration. Substantial sovereign issuance and sizable fiscal gaps may keep long-term yields high, while a settlement in the Iran war could lower expectations for additional hikes and drag short-dated yields down. If you are watching from the sidelines, the action is up front and the long end is still a tough crowd.
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