Bank of America Warns Markets May Overreact to Energy Price Surge

Bank of America (BofA) believes that markets are pricing in too many European Central Bank (ECB) rate hikes in response to rising energy prices. The bank's strategist, Ralf Preusser, argues that investors may be overreacting to the current surge in natural gas prices, which has pushed futures markets to price almost four full ECB rate hikes during the current cycle.

The increase in energy prices is indeed a concern for the euro area, as it can directly feed into headline inflation through electricity and fuel prices. However, Preusser notes that even with the run-up in natural gas prices, futures markets are pricing in a scenario that is entirely consistent with the ECB's base case.

BofA compared the energy prices implied by futures with the ECB's June projections and found that they remain broadly consistent with the central bank's base case. This suggests that the market may be reacting to the headline move in energy prices more aggressively than the underlying ECB projections justify.

The bank expects the ECB to raise rates during the current cycle but then cut them again next year, which is not fully priced by markets. BofA favors strategies designed to take advantage of what it sees as an overly steep interest rate curve, such as receiver calendar spreads and BTPei barbells weighted as forward flatteners.