The steepness of the yield curve

Following yet another disappointing jobs report and the latest revisions, market participants now expect an interest rate cut (and possibly further cuts) in the US soon. In Europe, the cycle of rate cuts is likely already over. Looking at the yield curve, we can see that it is becoming steeper. What does this mean? The yield curve shows the relationship between short-term and long-term yields. At the short end (deposit rate), central banks decide on the interest rate. The long end, on the other hand, is determined by the market – by expectations of growth and inflation, by the supply of bonds, by demand (e.g., safe-haven purchases) and by global influences. In the past, developments in the US yield curve have often had spillover effects on Europe.

From inverse back to normal

After the rapid rise in interest rates since 2022, the curve in Europe was more inverse than it had been in decades: short maturities had high interest rates, while long maturities had relatively low rates because investors expected key interest rates to fall later. When monetary policy easing begins, i.e., interest rates are lowered, the picture usually normalizes: short-term interest rates fall first. At the same time, long-term yields may rise—for example, because the economy is performing better than expected, because inflation risks remain persistent, or because investors are again demanding a higher risk premium for long maturities. If there is also a higher bond supply because central banks are buying fewer government bonds, the market demands an additional premium for long maturities. The result: the curve becomes steeper – long-term yields rise even though short-term yields fall.

Historically, the spread between the ECB's key interest rate, i.e., short-term interest rates, and the yields on 10-year German government bonds (Bund yields) has fluctuated sharply. There have been phases above +2 percentage points, but there have also been inverse curves. On average since 2000, the difference has been around 0.5 percentage points – currently it is roughly 0.7 percentage points (ECB key interest rate ~2.0% vs. 10-year Bund ~2.7%).

What could cause long-term yields on European government bonds to rise?

• Better economic data: Positive surprises raise real earnings expectations – longer maturities could then tend to rise.
• Stubborn inflation: Even if overall inflation falls, persistent core components can support long-term expectations and the corresponding risk premium.
• More supply, less support: High net issuance and expiring reinvestments by central banks historically argue for steeper curves.
• US spillovers: Rising US long-term yields often spill over to Europe.

Political risks such as the current political instability in France could have a negative impact. Investors could then invest more heavily in German government bonds, which are considered safer.

What does this mean for investors?

Overall, the current environment points to a steeper yield curve. Among other things, this has an impact on borrowing costs. Variable-rate loans become cheaper, while fixed-rate loans could become slightly more expensive again. It also influences the expected returns on bonds.

Government bonds from core EU countries can contribute to diversification in a mixed portfolio. In times of stress, they dampen fluctuations, while in calmer periods, rising yields open up more attractive returns. We manage our bond portfolio as part of our investment strategy and adjust the maturities accordingly.

This information represents a market overview and Kathrein's investment strategy based on its market opinion. It does not contain any direct or indirect recommendation to buy or sell securities or any investment strategy.

When investing in securities, price fluctuations due to market changes are possible at any time. Information and performance data relating to the past do not allow any reliable conclusions to be drawn about future results.