Rates Spark: USD-EUR spreads can widen more

Since Trump's election, global rates seem less correlated to US rates, also helping the euro swap curve move more independently. Trump’s tariff threats, for instance, are seen as inflationary for the US, whilst potentially deflationary for the targeted country, triggering opposite rate reactions. In the eurozone we already saw a strong repricing for more European Central Bank cuts when Trump initially threatened with tariffs against Canada, Mexico and China – whilst the impact was on the hawkish side for the Fed. The latest reaction to Trump's steel tariffs had almost no notable impact on euro rates.

When looking at the entire period since Trump’s election, the correlation between daily changes of the 2Y euro swap rates and 2Y UST yields actually fell to zero (see figure below). Further out the curve we also see that USTs have less spillovers than earlier in 2024. Before the elections in November, more than 50% of the daily variation in 10Y euro swap rates could be explained by changes in the UST yields. This is reduced to 14% since. Besides tariff threats there were other factors in play here, including the more downbeat data releases in the eurozone compared to the US.

With euro rates less tied to US dynamics, the spread differential with UST yields could widen further. The spread between the 10Y euro and the 10Y SOFR swap is now 175bp, just below the peak of 185bp in 2018. We see more scope for the front end of the euro curve to nudge lower in the near term, and the spillovers hereof further out the curve would put widening pressure on the back end too.