DOUBLING DOWN ON GILTS

DOUBLING DOWN ON GILTS Daniel von Ahlen

◼ We like long 10y Gilts vs JGBs, Bunds and USTs on diverging macro fortunes BoE can still cut rates next year. We think there's still significant downside for Gilt yields across the curve now that a US-Iran deal is coming into view. Markets continue to see almost two hikes priced in for the BoE by June next year – in effect, no cuts are priced in for the remainder of this cycle. We still think the BoE can cut rates next year as the labour market remains in the doldrums while signs of second-round effects from the energy shock are scarce. Indeed, UK wage growth has continued to decelerate sharply and is now at around pre-Covid levels (in stark contrast with other developed markets like Japan and the euro area). In addition, firms’ pricing plans do not appear to have changed since the Iran war first erupted in February: the BoE agent survey on price growth is effectively unchanged, while inflation expectations have fallen across a broad set of measures.

In general, a negative output gap, a languishing labour market, soft real income growth and unambiguously restrictive monetary policy should alleviate concerns around sticky underlying inflation in the UK. The macro backdrop in Japan, the euro area and the US look stronger, and we see more downside to Gilt yields relative to Bunds, JGBs and USTs.

Upside risks to US rates. We believe the US macro fundamentals will eventually force the Fed to tighten (starting in September, followed by four more hikes next year). Recent dynamics in the US labour market (very low layoffs, a rebound in hiring, an inflection in the V/U ratio and a broad improvement in regional Fed hiring surveys) suggest the Fed's focus should be squarely on its inflation mandate. Beneath the surface, wage inflation pressure is already building. Average hourly earnings excluding in the education and health services sectors are accelerating, while some regional Fed surveys point to firmer wage growth in manufacturing. This should raise

Sharply decelerating wage growth in UK Employment PMI continues to contract

Sources: Macrobond, GlobalData TS Lombard. Sources: Macrobond, GlobalData TS Lombard.

Inflation expectations sharply lower No strong signs of second-round effects yet

Sources: Macrobond, GlobalData TS Lombard. Sources: Macrobond, GlobalData TS Lombard.

alarm bells at the FOMC as to how supercore inflation (which remains sticky) can decline from here amid the budding pressure in wage growth (see charts in yesterday's Macro Strategy).

ECB to deliver two more hikes. We think there will be another two ECB hikes in this cycle (close to market pricing) given the strength of the euro area labour market and strong signs that wage growth is settling in the 2.5–3% range. This suggests there isn't much downside for 10y Bund yields from current levels.

BoJ on track to accelerate tightening. The BoJ delivered a hawkish hold at last week's presser, emphasizing that financial conditions were accommodative and that the economy was resilient to higher rates. Inflation is projected to be at or above target for the entirety of the forecast period. More important, the BoJ stressed that "risks are skewed to the upside", adding that rising inflation expectations posed a danger to its price stability goal. Governor Ueda said “[we] need to be more aware than ever of the risk that inflation will rise faster than expected." That is a clear hawkish shift. Previous weak spots in the Japanese macro data (e.g., income growth and housing) have turned, which should reinforce the BoJ's assessment of the economy's resilience to higher rates. The trajectory of wage growth in Japan continues to imply much higher services inflation over the coming years and, with it, sticky JGB yields.

Strong European labour market Euro area wage growth settling at higher levels

Sources: Macrobond, GlobalData TS Lombard. Sources: Macrobond, GlobalData TS Lombard.

Macro Strategy | 05 August 2026 2