(Bloomberg) -- One of the bond market’s favorite trades is getting fresh momentum in Europe, as the worst rout in German bonds in more than two decades propels selling of long-term debt.
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The trade, known as a curve steepener, is a bet that securities maturing in the more distant future will underperform shorter-term notes. That was the case last week, when the gap between two- and 10-year German yields widened the most in two years after Germany unveiled plans to invest hundreds of billions of euros in defense and infrastructure.
Investors including Goldman Sachs Asset Management, State Street Global Advisors and Nuveen are among those wagering European yield curves will steepen further. The market will demand higher returns to buy long-term debt, the thinking goes, given that higher government spending is likely to result in years of increased bond issuance, faster growth and a possible pickup in inflation.
It’s a bold call that comes ahead of the measures passing through Germany’s parliament. Bunds rallied on Monday as the nation’s Green party said it will reject the spending plan — a move that would potentially kill it — while signaling they’re open to negotiations.
“The bund steepener is going to continue to be a dominant theme through the end of the year,” said Laura Cooper, head of macro credit and global investment strategist at Nuveen. She sees 10-year yields rising to 3.1% by then, with two-year yields at 2.25%.
Betting on steeper curves was already a popular trade heading into the year, but investors had been focusing on aggressive interest-rate cuts from the European Central Bank pushing down short rates as the trigger for the move.
The expectation was that US President Donald Trump’s tariff threats would likely pressure the ECB to sustain cuts, with monetary easing tending to have a larger impact on short-maturity bonds.
Last week, though, the ECB signaled it may be near the end of its rate cuts as inflation cools and governments prepare to ramp up fiscal stimulus.
At the same time, the trade gained another, potentially stronger impetus from all that stimulus: Germany and the rest of the Europe Union are preparing to increase spending on defense while easing the bloc’s rules on deficit spending.