Macro Trade #1: Long United Kingdom Bonds, Gilt 4.25% 07dec2055 Short German 30Y Bunds.

I’ve been closely analyzing duration bonds in Developed Markets, particularly in light of rising geopolitical risks stemming from the Trump Administration. My primary focus has been on UK bond yields and their notable divergence from both EU and US yields.

Before delving into the trade and its underlying rationale, I want to first outline my macro perspective on the future of the EU and UK. Recent developments suggest that Trump is pushing for reciprocal tariffs and a reduction in US military spending within NATO, which could significantly reshape Europe’s economic and political landscape.

Macroeconomic Outlook for Europe and the UK

In the short term, I expect these geopolitical shifts to trigger an economic shock, dampening growth across the region. However, in the long run, the more profound effect will be a sharp increase in public debt across Europe. As NATO funding gaps widen, European governments will likely be forced to boost military spending, putting additional strain on fiscal budgets.

From a monetary policy standpoint, I anticipate that both the European Central Bank (ECB) and the Bank of England (BoE) will face political pressure to revert to accommodative policies, easing back to pre-pandemic levels. With fiscal deficits expanding to match US military spending as a percentage of GDP, central banks will likely be coerced into keeping borrowing costs low to sustain rising debt levels.

How Will This Be Funded?

Governments have two primary options:

1. Raising taxes – Unlikely, as tax rates in the EU are already high, leaving little room for further increases without political and economic repercussions.

2. Issuing more debt – The more politically palatable option, but it comes with significant interest rate risk in the current economic environment.

With long-term rates (+20y) in the UK exceeding 5%, I see this as a “risk-free” trade in the current economic cycle. Unlike the EU, the UK is in a better position regarding tariffs, which should reduce inflationary pressures over time. While the UK’s inflation trajectory has been significantly worse than the EU’s in recent years, I expect it to normalize to historical trends, remaining roughly 0.5% above EU inflation in the long run.

This presents an opportunity to position in long-duration UK bonds, particularly given the high real yields and the likelihood of an eventual monetary policy pivot as the UK and EU grapple with fiscal expansion and slowing growth.

I would be overweight this trade given the thesis above and add short position equal weighted size of 30 Year duration German bunds as they look compelling at 2.5% given the upside room on inflation and growth.

Disclousure: I am long 80K at 86.6 and at a yield of 5.1% and short 80K at a yield of 2.6%. I see a path for the yield to drop to 4% as a base scenario and to 3% in a recession scenario.