BofA Sees Opportunity as Euro Rates and Inflation Expectations Misalign

Bank of America's strategist Ralf Preusser believes that euro area interest rates and inflation expectations are out of sync, creating an opportunity for traders. According to BofA, markets have priced in almost four full European Central Bank (ECB) hikes since the start of the war in Iran, but Preusser argues this is overdone.

The bank notes that natural gas prices have reached new highs, pushing futures markets to discount a scenario consistent with the ECB's base case. However, Preusser explains that even with these price increases, the weighted average of gas and oil implied by futures remains in line with the ECB's June base case and well below its adverse scenarios.

To justify further hikes beyond the 60 basis points already embedded in forecasts, significant upside surprises to energy prices would be required. Preusser sees the real yield curve as too steep, making real rates look cheap.

BofA expects interest rate hikes this year to be followed by cuts next year, a view not reflected in current market pricing. The bank recommends trading strategies such as receiver calendar spreads, barbells weighted as forward flatteners, and 'gamma breakeven' trades pairing inflation longs with payer shorts.