UBS Fixed Income-Global Rates Strategy _Rates Map - Powells prudent put, Bun...-117451573

ab26 August 2025Global ResearchGlobal Rates StrategyRates Map - Powell's prudent put, Bund bears, and short OATs US - Lowering target on 5y US after Jackson Hole
A year ago, we discussed the "return of central bank puts" where the Fed takes action to support a stable labour market. We believed that sentiment was too hawkish going into Jackson Hole and Chair Powell indeed emphasized downside risks to employment. However, the current "Fed put" differs from last year's as the Chair also emphasized that the Fed "will not allow a one-time increase in the price level to become an ongoing inflation problem." Inflation swaps give an indication of the challenge ahead. US 2y inflation swaps traded close to 2% a year ago but rose above 3% on Friday (Figure 2Both 1y1y SOFR and 2y US inflation swaps are now trading above 3%. In the euro area, both 1y1y ESTR and 2y EUR inflation swaps are trading below 2%. ).
We lower our target on our long US 5y to 3.60% but are waiting for better entry points to go long the front-end ahead of the release of the August jobs report on Friday, September 5. UBS expects core PCE price inflation of 2.91% yoy in July, which aligns with consensus.
The Fed intends to reduce reserves and we have received several questions on the implications of tighter US liquidity. Dallas Fed President Logan said that repo rates are running ~8 bps below interest on reserves, suggesting that there is more room to reduce reserves. In response to the repo crisis in September 2019, the Fed also introduced the Standing Repo Facility, which allows investors, via primary dealers, to repo their treasuries for cash dollars for liquidity purposes.The facility should help in case of any quarter-end pressures. Taking a broader perspective, total loan growth at commercial banks is running at 4.4% YoY but as UBS economists have emphasized, the demand for credit looks weak (Figure 4Total loan growth at US comercial banks is runing at 4.4% yoy but the demand for credit loks weak). Euro area - Short France vs swaps as back-to-school trade
We go short 10y French bonds (OATs) vs swaps targeting a spread of 85 bps, with a stop at 70 bps, ahead of the confidence vote on 8 September and discussions on the 2026 budget. We think that 10y France vs swaps could rise above 90 bps in case of a fall of the government and 110 bps in case of new legislative elections. This is our first position in OATs after we closed a 2s10s steepener in spring. We would also expect OATs to underperform versus bunds. Nevertheless, we prefer to position against swaps as we see risks that German bunds will underperform swaps, setting the stage for broader underperformance of European government bonds.
We do struggle to see a more material widening of French spreads. Investors have a much better understanding of the complexity of the budget process compared to a year ago. France also has constitutional safeguards to prevent a US-style shutdown. Furthermore, the French bond market remains