A strategy for US investors to counter domestic market risk involves buying European bonds and not hedging the currency. This combines a modest ~3% bond yield with an expected ~7% appreciation of the euro against the dollar, driven by diverging central bank policies.

Despite a sizable fiscal boost, Germany is not expected to experience rising term premium. The country's debt-to-GDP ratio remains low, and strong demand from the private sector and foreign investors is forecast to easily absorb the increased bond supply, containing upward pressure on yields.

In 2026, major central banks will diverge significantly. The U.S. Fed and ECB are expected to cut rates in response to slowing growth and disinflation. In stark contrast, the Bank of Japan is poised to hike rates as it finally achieves reflation, making it the sole hawkish outlier among developed market central banks.

The Estet-Sofar basis is in a "tug of war." Diverging rate policies, where the market prices Fed cuts against a European Central Bank on hold, support a wider basis. However, the Fed's accommodating balance sheet policy (T-bill purchases) relative to the ECB's supports a narrower basis. This results in an expectation for the basis to remain in a tight range, albeit with a slight widening bias.

Global diversification away from the US dollar, accelerated by geopolitical tensions, is creating structural demand for Eurozone Government Bonds (EGBs). This acts as a buffer, making Euro area term premia less reactive to global rate sell-offs in markets like the US and Japan, a trend expected to continue.

Germany's finance agency signaled it would adjust debt issuance in response to a steepening yield curve. This sensitivity acts as a structural anchor on intermediate-term yields, creating a potential outperformance opportunity for German bonds versus US and UK debt, which face greater fiscal pressures.

The Fed is prioritizing its labor market mandate over its inflation target. This "asymmetrically dovish" policy is expected to lead to stronger growth and higher inflation, biasing inflation expectations and long-end yields upward, causing the yield curve to steepen.

The US economy's structure as an energy exporter, combined with the Federal Reserve's dual focus on both inflation and labor markets, means US yields react less dramatically to oil price spikes than European rates. This structural difference provides a relative buffer against energy-driven volatility.

A significant split in monetary policy is expected in 2026. The US Federal Reserve and European Central Bank are predicted to cut rates in response to slowing growth and easing inflation. In stark contrast, the Bank of Japan is on a hiking cycle, aiming to reflate its economy.