Rates Spark: EUR rates cannot follow a dovish US

Euro rates continue to do their own thing and especially the front end seems relatively isolated from US dynamics. The sharp dovish move in US rates on the back of benign inflation numbers was barely noticeable for the 2y euro swap rate. Oil is clearly the main driver and therefore Brent reaching as high as US$87 per barrel is a more important variable to watch. At these prices, the 2y swap rate almost hit 3%, which marks the highest level since the start of the conflict.

Also, the eurozone inflation data will be pivotal in challenging the hawkish market positioning, but we may have to be patient. July’s figures are still weeks away and even then, those numbers will not be enough to comfort markets about second-round risks. Especially with oil prices surging again, the full pass-through of higher energy prices will remain difficult to estimate. An added complexity is the rise in natural gas prices, which are now at the highest levels since March. Meanwhile, European gas reserves still seem relatively low and will have to be filled before winter starts approaching.

All this uncertainty means markets’ European Central Bank pricing can continue to diverge from the Fed’s. The momentum in US inflation should be downwards, whereas for Europe the peak might not be in sight yet, especially if energy prices continue to drift higher again. So, while we are bullish on both 2y USD and EUR rates, the US leg might find itself coming down earlier.