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Theme · past 12 monthsUS, Euro area, UK, Japan

The cycle turned: from rate cuts to rate hikes

The war flipped the cycle from cuts to hikes, so the front end did the repricing and curves bear-flattened before the hikes even arrived.

What it did to the curve

Front end

Yields higher

2-year

Long end

Yields higher

10–30-year

Curve

flatter

long minus short

The US 2-year rose about 119bp (3.53% on 10 Oct 2025 to 4.715% on 16 Oct 2026), more than the 10-year’s about 104bp (4.05% to 5.085%), so 2s10s flattened from about +52bp to about +37bp.

Fed funds target range

3.75–4.00%

down−25bp on the year

Two cuts, five holds, then a hike on 16 Sep 2026 that only reversed December’s cut.

ECB deposit rate

2.50%

up+50bp on the year

Held at 2.00% until June, then hiked in June and September as staff lifted their 2026 inflation projection to 3.0%.

BoE Bank Rate

3.75%

down−25bp on the year

The laggard: no hike yet, but a November hike is priced at about 83–91%.

US 2-year yield, 16 Oct

4.715%

upabout +119bp on the year

From 3.53% on 10 Oct 2025: the front end priced the turn from cuts to hikes.

What happened

Twelve months ago the question was how far rates would fall. The Fed cut on 29 October and 10 December 2025, to 3.50–3.75%. The BoE cut to 3.75% in December, and in February four of its nine members still voted for another cut. The ECB sat at 2.00% and the BoJ at 0.50%.

The Iran war, from 28 February, changed the arithmetic. Brent went from about $70–74 before the war to above $126 on 30 April. At his last meeting as chair, Powell called it the fourth after the pandemic, Ukraine and tariffs.

One shock can be looked through, or treated as temporary; a run of them risks in wages and expectations, so central banks stopped waiting. The ECB and BoJ hiked in June and September, and the Fed on 16 September, its first hike since July 2023. Even so, the Fed’s upper bound is 25bp lower than a year ago: September’s hike only reversed December’s cut.

When a cycle turns, the front end does the repricing, because the 2-year is mostly a forecast of policy. The US 2-year rose about 119bp on the year, against about 104bp for the 10-year. That took from about +52bp to about +37bp, a bear flattening. All of it came before the hike: 2s10s was about +36bp on 14 September.

The BoE is the laggard. Its hawks, the members pushing for higher rates, grew to three of nine by July, and a November hike is priced at about 83–91%. That is the at work: once a central bank signals it can’t look through a shock, markets price the whole path at once.

Timeline

  1. · US

    Fed cuts 25bp to 3.75–4.00% and says QT will end on 1 Dec

  2. · UK

    BoE cuts Bank Rate to 3.75%; the Fed had cut again on 10 Dec, to 3.50–3.75%

  3. US–Israeli strikes on Iran begin; Iran declares the Strait of Hormuz effectively closed

  4. Brent briefly tops $126, its wartime high, the day after Powell’s last meeting as Fed chair

  5. · Euro area

    ECB hikes to 2.25%, its first hike since September 2023

  6. · UK

    BoE holds at 3.75%, with three of nine members voting to hike

  7. · US

    Fed hikes to 3.75–4.00% (12–0), its first hike since July 2023

What could change it

Base case

The turn completes on schedule. The Fed skips October and delivers a second and final hike in December, as Goldman expects, and the BoE starts on 5 Nov, as 54 of 63 economists in a Reuters poll expect. Front ends hold near their highs and curves stay flat.

Watch: FOMC, 27–28 Oct · BoE, 5 Nov · FOMC, 9 Dec

Hawkish risk

Brent, at $109.86 on 16 Oct, keeps climbing and inflation keeps surprising. Markets price more hikes into 2027 and the bear flattening resumes, led by the UK and euro front ends.

Watch: UK CPI, 21 Oct · ECB, 29 Oct · US PCE, 29 Oct

Relief rally

Hormuz reopens, which Iran said on 18 Oct could happen within six days if the US accepts its terms, and second-round effects stay absent, as Bailey and Lagarde said in mid-October. The BoE hikes once and stops, the Fed skips December, and front ends rally, steepening curves.

Watch: UK CPI, 21 Oct · BoE, 5 Nov · FOMC, 9 Dec

How desks express it

UK 2s10s bear flattener

Curve

Sell 2y gilts, buy 10y gilts (DV01-neutral)

The BoE is the next bank to turn, and when a bank turns, the 2-year reprices faster than the 10-year.

  1. 1

    In the US, hike expectations lifted the 2-year more than the 10-year, so 2s10s fell from about +52bp to about +36bp by 14 Sep, before the first hike was delivered.

  2. 2

    The BoE’s votes have swung from four for a cut in February to three for a hike, and the BoE path Lombardelli cited has CPI at about 4.2% in Q1 2027.

  3. 3

    A DV01-neutral gains if UK hike expectations rise faster than long gilt yields, whatever the level.

  4. 4

    The BoE stopped selling long-dated gilts in September, removing one source of pressure on the long end.

Wrong if: The UK long end carries its own fiscal risk: a Budget on 28 Oct that disappoints on headroom could lift 10-year yields faster than 2-years. And with about four hikes priced by end-2027, a dovish hike on 5 Nov, in line with Pill’s pushback on pricing of four rises over the next 12 months, would rally the front end.

UK vs German 2-year spread

Cross-market

Sell 2y gilts, buy 2y Schatz (DV01-neutral)

The ECB is two hikes in and letting higher market rates help; the BoE is about to start, and its hawks don’t want markets doing its job.

  1. 1

    The ECB has hiked twice, to 2.50%, and on 17 Oct Lagarde said higher long-term rates will slow growth and limit pass-through more than projected.

  2. 2

    The BoE hasn’t hiked yet. Greene said on 8 Oct that markets shouldn’t be assumed to do the Bank’s work, and that pay near 3.5% is too fast.

  3. 3

    If the BoE’s cycle runs further than the ECB’s from here, UK 2-year yields rise relative to German ones.

Wrong if: The BoE may stop early: Pill pushed back on pricing of four hikes over the next 12 months, and Bailey sees little evidence yet of second-round effects. A soft UK CPI on 21 Oct, or an ECB hike on 29 Oct (the IMF expects at least one more this year), would narrow the spread.

Educational expressions of the theme — how a desk might position, not advice.

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