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Tariff-mania has largely faded into the background as central bank activity and fiscal sustainability concerns have come to the fore. Whilst the UK, the US and Europe are at different stages in their monetary loosening cycle, the experience of curve steepening (longer-dated yields rising relative to shorter-dated yields) has been eerily similar, denoting a global phenomenon albeit with varying drivers.
In the third quarter of 2025 markets largely became inured to tariff announcements and rollbacks and seemed to accept this news-flow as the new normal; instead, the focus became centred on what individual economies were prepared to do to protect or defend against tariff woes and their consequent impact on growth. The US Fed had been on hold for much of 2025, hoping to parse the impact of tariff wars on inflation and the economy at large. Yet President Trump was not supportive of this passivity and embroiled himself in various mechanisms to put pressure on the Fed to reduce rates, musing over potential irregularities in office renovations and directly targeting individuals on the panel as well as publicly considering the end of Jerome Powell’s term as Chair of the Federal Reserve. Whether through threat or otherwise, a vocal group calling for a reduction in the base rate started to gain traction and they implemented a 0.25% cut in both September and October, to an upper bound of 4% – a trend that is widely anticipated to continue in the following months (despite a lack of economic data due to the government shutdown. The UK’s Bank of England cut rates by a quarter point to 4% in August, despite persistent inflation. Meanwhile, the European Central Bank (ECB) held firm on their 2% deposit rate, with many believing that this level represents the neutral rate; it is a level that permits additional loosening should the situation demand it to support the European economy. There are a number of risk factors in Europe that have developed over 2025. First is the expansion in defence spending to counter the threat of Russia and President Trump’s lukewarm approach to NATO. Second is the political instability seen in France, resulting in a three-way split in Parliament, over which a series of centrist Prime Ministers have struggled to manage to promote much needed reform as the fiscal situation deteriorates.
The lack of market confidence in France and its potential to control its spending was displayed in a stark fashion by the double downgrades to single A by S&P and Fitch. Whilst the challenges of cutting spending and how this might impact the country’s rating had been much flagged, the surprise was S&P moving ahead of its standard schedule in October (the rating review was due for November), citing a lack of faith in the second attempt of Prime Minister Lecornu to evade a series of no-confidence votes. The French economy is in the unique position in Europe of having struggled to grow despite extensive support from the ECB, low financing costs and Europe-wide spending plans. It suffers from a high negative current account and a budget deficit, and this is coupled with extensive corporate and private debt. Now that yields have increased, this debt burden looks increasingly unsustainable. The concessions required to maintain Prime Minister Lecornu in his position and pass a Budget will result in reforms being watered down, thus potentially becoming ineffective in reducing the deficit. Pension reform is vital in France; it has the longest retirement in the world at 25 years and the payments are so generous they outstrip the average worker’s wage. Pension reform is on the mind of many, as Europe and the US contend with ageing populations, resulting in pension provision that appears ever more unaffordable.
In the Netherlands, as the upcoming transition date of 1 January 2026 looms closer, the series of announcements as to whether a scheme intends to transfer to the new pension system has ramped up. In recent months several high-profile pension funds have announced a delay in transition until January 2027 or later, totalling an estimated EUR80bn of AUM. In previous quarters the expectation had been that there would be a tidal wave of activity around 1 January 2026, now that certainty appears to have been tempered somewhat, with some hedge funds trimming positions as they consider how much potential there is for the curve to steepen further, particularly as recent equity performance has bolstered transitioning schemes’ funding ratios, impacting indexation and liability hedging needs. As a reminder, the broad expectation of pension activity moving to the new system is that schemes will require less long-dated hedging (although they may require more at shorter tenors). Given the concentration of Dutch pension funds in the long end of the European swaps and bond markets, this has been one of the most popular and theoretically predictable market moving events in an uncertain geopolitical environment. So why are expectations evolving? Whilst the broad outline of a shortening of hedging requirements remains true, the impact on markets will much depend on each scheme’s transition date, their current positioning and their overall solvency level.
Market Outlook
We asked investment bank derivatives trading desks for their opinions on the likely direction of key rates for liability hedging. The aim is to get information from those closest to the market to aid investors in their decision-making.
The results are shown below as the number of those predicting a rise less those predicting a fall, as a percentage of the number of responses. The larger the balance, the more responses predict a rise. The more negative the balance, the more responses predict a fall.
Chart 1: Change in swap rates over the next quarter
Source: Columbia Threadneedle Investments. As at 30 September 2025
In the previous quarter the greatest conviction was for higher swap yields, which came to fruition. This is a continuation of the global and European-specific curve steepening trend.
There is little certainty on the expectations for how yields will end 2025. The highest conviction is for swap yields to maintain their upward momentum. This is a function of the ongoing tendency for steeper curves, but also noting the lessening of growth concerns caused by US tariffs. There are a variety of views on the German fiscal situation and whether the increased spending will be sufficient to drive economic growth or merely to fuel consumption.
Given the importance of monetary policy and its support for the European market, we asked our counterparties for their expectations of the terminal level for the European base rate and at what point this level would be attained. The most popular response by far was that the terminal level of 2% had already been reached and this would be the end of the monetary easing cycle, with some pointing to a rate hike in 2026. However, some do believe there is further to go, but with little consensus on when, as shown in the chart below:
Chart 2: Expectations of terminal Bank Rate
Source: Columbia Threadneedle Investments. As at 30 September 2025
It is clear that, even if the terminal rate has not yet been reached, there is a view that there is not much further to go, with 1.50% providing the floor. The impact of inflation needs to be incorporated for forward-looking views on the base rate. One impact of the US tariffs is the disinflationary impact of a stronger Euro on imports and an influx of Chinese goods. Whilst the ECB has not explicitly accounted for such Chinese imports, their core goods inflation projection is lower than consensus so is likely to form part of their expectations. Equally, these disinflationary effects are helpful to counter the pressure from higher spending, allowing the ECB more room to manoeuvre.
To round off our sampling of market views we asked about the hot topic of 2025 (and maybe years to come!): could European curves steepen from here, especially given the steepening seen already? For reference 10s30s (i.e. the difference in yields between the 30-year and 10-year point) has steepened by c. 50bps YTD. Interestingly, 20% of our respondents felt that the steepening had been overdone, driven by hedge fund expectations, and they felt that the more likely outcome would be a flattening move from here. For those who saw further value in the steepening position, estimates for further moves varied in a wide range from +0.05% to +0.40%. This variety was understandable given the uncertainty over the extent of market positioning weighed against the likely Dutch pension reform flow and global drivers. As previously highlighted, the curve steepening has been a global phenomenon and not solely due to Dutch pension reform; it comprises a reflection of worries over central bank independence in the US, fiscal challenges and supply versus demand factors.
If you would like to learn more about any of the topics discussed, please contact your client director.
