GERMANY: Light Downside In Bund Futures As Bundestag Approves Defence Package

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• Plotting current 10-year yields against the EC’s 2027 debt/GDP projections, France and Germany have the largest deviation from the trendline (we exclude Ireland from this analysis as the EC/IMF don’t project adjusted GDP, only total nominal GDP).
• For Germany, this likely reflects 10-year Bund’s safe haven properties. In the case of France, we interpret it as a crude estimate of political risk premium – currently around 15bps.
• Relative to the IMF’s latest Fiscal Monitor, the EC’s Autumn forecasts appear to embed more front-loaded German fiscal easing. The EC projects a slightly larger cyclically adjusted German primary deficit in 2026 than the IMF, but a smaller deficit in 2027 (see charts).
• The EC is more optimistic than the IMF on fiscal consolidation in some countries. 2026 and 2027 cyclically adjusted primary deficits in Belgium and France are visibly larger in the IMF’s Fiscal Monitor than in the EC's forecasts.
• Overall though, 2027 debt/GDP projections from both institutions are quite similar across countries.

Although markets have demanded higher gilt yields after press reports signalled an income tax rate hike u-turn from Chancellor Reeves, long-dated UK swap spreads remain some distance off their respective year-to-date/cycle lows.

• There are several counter points to consider here:
• Cross-market impulses, with long end U.S. & German spreads off cycle lows. Markets were also dealing with U.S. “Liberation Day” turbulence (which pressured U.S. swap spreads) and the German “whatever it takes” fiscal moment (which pressured German swap spreads) around the time of April’s sell off in UK swap spreads.
• The DMO & BoE have been nimble when it comes to shortening the WAM of supply, which has alleviated pressure for long end gilts on several occasions. There are expectations for an ongoing skew away from long end issuance.
• The UK is further along the disinflationary path than it was back in April.
• While income tax rate hikes have seemingly been scrapped, the fiscal stance is still expected to tighten in next week’s Budget. Outside of the pure fiscal implications, the Budget is set to hamper economic growth, which could expedite further BoE easing. 

Fig. 1: UK 10- & 30-Year Swap Spreads (bp)

Source: MNI - Market News/Bloomberg Finance L.P.