The long-end of the European government bond yield curve, a favored trade for institutional investors, has been heavily disrupted by U.S.-Iran military actions this year. Despite repeated setbacks, traders remain committed to betting that 30-year swap rates will rise more than their 10-year counterparts, a strategy known as curve steepening.
This trade, which involves speculating on a widening spread between 10-year and 30-year European swap rates, gained momentum during a lull in Middle East hostilities in May and June. However, renewed U.S. military strikes in July pushed oil prices back above $100 per barrel, squeezing the spread and reversing some of the earlier gains. The core logic behind the persistent investor interest is a structural shift in the Dutch pension system, which is transitioning to a defined-contribution model, reducing demand for long-dated bonds, combined with a growing supply of European government debt.
The conflict initially pushed up short-term rates due to inflation fears, erasing about 60% of the steepening that had occurred earlier in the year. The 10-year to 30-year spread now sits at roughly 8 basis points. However, the trade offers a positive carry of about 7 basis points per year, providing a buffer for investors who are betting on a potential ceasefire to lower front-end yields and re-establish the steepening trend. This is seen as a "low-beta hope trade" by hedge funds, relying on a de-escalation of conflict and a re-pricing of long-term supply and demand dynamics rather than a sure arbitrage opportunity. The key risk remains that the European Central Bank (ECB) could still hike rates, with the market pricing in about 42 basis points of tightening by year-end, which could further flatten the curve.
Geopolitical Shocks Undermine Europe's Steepening Trade
The unwinding of the eurozone curve steepening trade in March was a painful experience for many market participants, according to Julian Baker, co-head of linear rates trading for EMEA at JPMorgan. He noted, however, that the 10-year to 30-year steepening trade remains popular with the bank's institutional clients, who are betting that long-term bond yields must rise to absorb the expanding supply of government debt. This trend has been a global phenomenon, but it has been particularly pronounced in Europe since the end of 2024, making it one of the most crowded market positions.
The trade was further boosted in 2025 by the Dutch pension reform, which shifts the country's €1.6 trillion ($1.8 trillion) pension system toward a defined-contribution model. This structural change is expected to reduce the mechanical demand for ultra-long bonds and swaps, pushing long-term rates higher to attract capital. While the trade has suffered short-term losses from the geopolitical shock, the underlying logic of "increasing long-term bond supply and structurally weaker demand" remains intact. The 10-year to 30-year swap spread widened by over 50 basis points last year, the second-largest increase on record since 2009, before the U.S.-Iran conflict in February 2025 reversed about 60% of that move.
The spread has since recovered some ground on hopes of a lasting ceasefire but has flattened again recently, hovering around 8 basis points. Data from Barclays indicates that the recent escalation in U.S.-Iran tensions did not trigger a massive new wave of position liquidations, only moderate reductions, suggesting that many investors still expect short-term bonds to outperform long-term bonds, even with the possibility of further ECB rate hikes. The ECB's decision last week to pause its rate-hiking cycle, while signaling readiness to act again, has led the market to price in 42 basis points of tightening by the end of the year.
Ceasefire as a Key Buy Signal; Positive Carry Bolsters the Trade, but Volatility Remains a Risk
The primary reason institutional investors are sticking with the curve steepening trade is the potential for a "bull steepening" if there is a credible de-escalation in the Middle East. A ceasefire could lower oil prices and inflation expectations, pushing short-term yields down and widening the spread. The trade also benefits from a positive carry of approximately 7 basis points per year, which improves the holding tolerance for investors. However, the trade is highly sensitive to implied volatility and remains path-dependent on the convergence of geopolitical events, ECB policy, and pension fund flows.
Rohan Khanna, a managing director at Barclays, wrote in a recent research note that the curve steepening trade offers a "low-beta hope trade" for investors. He argued that if there is a credible de-escalation, front-end yields should fall, leading to a bull steepening. From his conversations with clients, this remains a preferred expression of a market view once confidence in a war's conclusion grows. However, other market veterans are less convinced, given the high sensitivity to unpredictable volatility. Strategists at Citi, including Andrea Appendino and Jamie Searle, advised caution, noting the trade's vulnerability to sudden shifts in implied volatility.
Strategists at ABN Amro have predicted that the steepening trend will peak in late 2026, as Dutch pension funds gradually reduce their holdings of long-term bonds and swaps. Julian Baker from JPMorgan emphasized that the combination of a macro and structural logic, along with a positive carry, makes the 10-year to 30-year steepening trade a very attractive proposition for large institutional clients. He noted that the positive carry, which is the expected profit from holding the position over time assuming static market conditions, helps offset the risk of the trade not immediately playing out. However, this carry is not a guarantee; if the curve flattens or volatility spikes, capital losses can easily exceed the carry gains.
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