Eurozone Markets Seen Overpricing ECB Hikes Amid Inflation Expectations Mismatch

Bank of America (BofA) has identified an opportunity in the Eurozone markets due to inconsistent euro area interest rate and inflation expectations. According to a note by BofA, prices have reached new highs since the start of the war in Iran, pushing markets to discount almost four full European Central Bank (ECB) hikes for this cycle.

However, strategist Ralf Preusser argued that this move is overdone. He noted 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.

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. For the central bank to feel pressured to do more than the 60 basis points of cumulative hikes embedded in those forecasts would require significant upside surprises to energy prices, Preusser explained.

BofA expects hikes this year to be followed by cuts next year, a view that is priced by neither curve. It favors receiver calendar spreads, barbells weighted as forward flatteners, and 'gamma breakeven' trades pairing inflation longs with payer shorts.