Global Rates: A long hot summer for front-end inflation markets
The desk asserts that front-end inflation markets will face increased pressure as geopolitical tensions, particularly in the US-Iran conflict and disruptions in the Strait of Hormuz, drive energy prices higher. Per the full note by J.P. Morgan, this environment leads to near-term risks in inflation expectations across major economies including the euro area, the UK, and the U.S. The recent upward movement in energy prices has already started affecting breakeven inflation rates, impacting how traders should position themselves in the FX markets. This analysis indicates that traders should brace for ongoing volatility, particularly with key data releases that may reflect these inflationary pressures.
What the desk is arguing
The desk posits that the re-escalation of geopolitical tensions and a rebound in energy prices will keep front-end inflation markets under stress through the summer months. Per the full note, this situation presents significant risks as inflation data from the euro area, the UK, and the U.S. may show a substantial uptick owing to these pressures.
The sharp reversal in energy prices observed recently highlights the potential for a shift in market sentiment, particularly evidenced by the rising breakeven rates mentioned by the commentators. This could lead to reassessments of central bank policies and future rate paths, affecting currency valuations across the board.
Where it sits in our coverage
While our internal data doesn't specify a consensus target for the related currencies, notable market players have varying targets for the upcoming months based on different inflation expectations and macroeconomic indicators.
How other firms see it
Firms such as jpmorgan and others align their perspectives with the potential for increased inflation risks causing strain on FX markets, primarily impacted by movements in energy prices. In contrast, bofa presents a more cautious view, anticipating lesser inflationary pressures that could keep the front-end stable.
With inflation considerations in mind, keep an eye on related currency pairs like EUR/USD, which are sensitive to ECB rate changes, as well as USD/GBP in light of potential BoE adjustments influenced by domestic inflation data.
01Geopolitical tensions and energy price recovery are setting up a volatile inflation landscape.
02Expect front-end inflation markets to react dynamically to incoming economic data from major economies.
03Positioning in FX markets may need to adapt to shifts in inflation expectations.
04Risk sentiment in the market could evolve rapidly based on renewed geopolitical developments.
Market implications
Traders should closely monitor the upcoming inflation reports as they may influence central bank policy views, particularly with energy costs pushing inflation expectations higher. EUR/USD and USD/GBP movements will be critical to watch as they reflect overall sentiment in relation to inflation risks.
Risks to this view
A notable downturn in energy prices or a significant de-escalation of geopolitical tensions could negate the inflationary pressures currently anticipated in the markets. Such developments would prompt a reassessment of the inflation trajectory, potentially leading to a decrease in volatility in front-end markets.
Hi, and welcome to At Any Rate, J.P. Morgan's global research podcast, where we take a look at some of the drivers behind the biggest trends and themes across fixed income, currencies and commodity markets. I'm Frida Infante from the European rate strategy team, and I'm joined by Harry Downey from our U.S. strategy team to discuss inflation and inflation markets in Europe and the U.S.
Before we kick off, though, if you have enjoyed listening to our podcast and reading our research, we would greatly appreciate your support for us and J.P. Morgan in the 2026 Excel Global Fixed Income Research Survey in the Inflation-Linked Bonds Voting section. Having said that, let me set the scene.
Last month, the story was all about the ceasefire and break-evens selling off, but this month that's flipped. Front-end inflation break-evens have rallied over the past few weeks, and energy is really the driver. Oil, and gas in particular, have pushed higher as hostilities in the Strait of Hormuz have resumed, and uncertainty around the U.S.-Iran conflict has grown.
Inflation curves have re-flattened. In net, 10-year break-evens are a little changed, and inflation curves in HICP, UKRPI and U.S. CPI space all remain inverted.
We've titled this month Outlook, a long, hot summer for front-end break-evens, and that's really what Harry and I want to get into today. So Harry, the story of energy driving break-evens higher was true across the U.S., Europe and the U.K., but after last week's CPI surprise, to the downside, that's no longer the case. What's been driving the move lower in the U.S.?
Yes, thank you, Farida, and hello, everyone. It's been really a mixture of softer economic data and a more hawkish Fed. On the data front, we first received the June employment report, which came in slightly softer than expectations.
The U.S. only added 57,000 jobs in June, and prime months were revised downward, which meant that the overall three-month pace of job growth in the U.S. was at a rip-roaring pace of 188,000 per month, but moved down to 111,000 per month. That took out really risk of a labor market reheating from the economy, and then additionally, we got the bigger surprise just last week in terms of CPI, where we actually had the largest downside surprise to CPI relative to economists' expectations since 2022, where both headline number and the core number were down month over month. Looking into the details, core inflation, which strips out that volatile food and energy components, actually fell, and there weren't really many positive signals for inflation markets across both goods and our services.
Some of the drivers were likely more temporary, including the ongoing tariff-related deflation in goods, a reversal of the World Cup bump, and the fact that housing inflation still reflects some of the distortions from last year's government shutdown. But the report itself creates quite a meaningful headwind for tips over the near term. Firstly, the negative CPI report means that carry will be turning negative for the asset class in August, which could scare away buyers from the market.
Secondly, while CPI declined 0.4% month over month, core PCE is still forecasted to rise in June. This wedge is important because while inflation markets price off of CPI, the favored gauge of the Fed for underlying trend inflation is called PCE. So this growing negative wedge is likely to cause a more restrictive and hawkish Fed than would typically be assumed for this level of CPI, and as such is a negative for tips.
And that's been driving the move lower. That softer patch of economic data is obviously running in contrast with the hotter signal we're seeing from rising gasoline prices. What do you think the net impact will be?
Yeah, we've long believed, similar to what you're seeing in Europe and the UK, that break evens look cheap and cheap relative to commodity prices and particularly gasoline prices. In fact, when we run our fair value models for break evens, they screen anywhere between one and three standard deviations cheap. That is one of the cheapest we've seen over the seven year horizons we model.
The challenge is finding a catalyst for those break evens to move higher. The key catalyst for markets and rates markets in the US is the July FOMC meeting. And we don't really have any tier one data releases before that meeting at the end of the month.
And the current trajectory of Fed communications has been skewing more and more hawkish, raising the risk that Chair Walsh in that meeting could lean in that direction. However, once we get past that meeting, we believe that data is likely to run a little hotter than current inflation market pricing. There are three reasons for that.
Firstly, that negative CPI PCE wedge that I highlighted just earlier, which resulted in a more restrictive Fed than would typically be expected for this level of CPI. We are expecting that to narrow and eventually turn positive once again, as the pace of shelter disinflation moderates. Now we are through the distortions associated with last year's government shutdown.
Secondly, we're expecting core inflation to remain sticky in the United States as labor markets continue to tighten gradually. Tariff related disinflation fades and some pass through from these higher energy prices begin to emerge. Thirdly, and finally, we don't think break evens fully reflect the impact of commodity prices with Brent crude trading back up near $90 per barrel.
Yet break evens, especially at the front end, trade below their five year averages. As such, we think it sets up an attractive medium term outlook for break evens in the U.S. once we get past this July FRMC. That's the U.S., Frida.
Let's cross across to the euro area. There's a lot going on. The June inflation print and then the sharp reversal up in energy prices.
Where do we stand now? Yeah, Harry, it's been quite the month. The headline story is that inflation actually came down in June, the first decline this year, and it came down more than we or the market expected.
Headline dropped to 2.8% from 3.2% the prior month and quarries to 2.4%. But when you dig into it, a lot of that softness is the kind you'd want to look through. So part of it was crude falling hard over the month of June.
Brent averaged around $85 a barrel in June versus something like $107 in May. And then another part of it was payback in holidays related services after the earlier bank holiday pattern that had impacted May. What hasn't changed is that services are still sticky and core is still running above target.
And crucially, that's being driven much more by wage drift and fading drags from tech prices than by anything energy is doing. So I'd say the underlying picture is firmer than the headline suggests. It was also an uneven dynamic across the region, which is worth flagging.
For example, France was the clear downside driver, falling all the way to 2% on lower fuels, softer food, and a broad-based core decline, so much of which is just summer sales timing. Germany looked similar on the surface. Headline was down to 2.4%, but core held firm at 2.5%.
So that's a fuel effect, not a genuine cooling. Spain actually surprised the other way, with headline flat at 3.6% despite falling fuel because higher gas and electricity offset the drag. And then Italy was somewhere in between, down a tenth to 3.10%.
And now, of course, energy has whipped straight back. The re-escalation in the Middle East has driven a sharp reversal. France's Brent is back around $88 a barrel, and TTF gas is at around 58 euros per megawatt hour.
That's triggered a hawkish repricing of ECB expectations and a real outperformance of front-end HICP swaps. But here's the interesting bit. Front-end sensitivity to oil has quietly faded, and quite significantly, whereas gas is the opposite.
Prices are at the highest since early April, and the sensitivity of one-year, one-year HICP to gas has picked up. So this time around, it feels like it's really more of a gas story. That's interesting, Frida.
So with all that sticky cool hawkish ECB, that energy whipping around, how are you thinking about the euro inflation market? And where do you see the risks? On the front-end, 2027 fixings have repriced around 20 basis points higher in the past month to average 2.7%, likely signaling a more persistent path through on the back of the ongoing energy shock and the uncertainty around it.
This aligns with the upside risk we flagged the previous time we published the podcast, and which are now materializing through the front-end. If you just look at our relative value framework, one-year, one-year HICP screens modestly rich versus one-year, one-year nominal rates and rolling front-ends. But I wouldn't read too much into that because there are a few things that the model isn't capturing right now, which is the higher risk premia around the conflict, the persistence in gas prices, and simply the uncertainty of the past weeks.
So we're comfortable looking past this richness. More importantly, we still see the risks due to the upside. If military action escalates further and disrupts flows through the Strait of Hormuz, there is a risk that Brent could push back towards $100 per barrel.
And the real question then is whether the pass-through into consumer prices will strengthen, because so far, that relationship has been milder than you would have expected. So our bias is fairly clear. In a further escalation, high energy would lift the front-end, while faltering growth and a decisive ECB would keep intermediate break-even stickier, and that combination argues for a flatter front to intermediate curve.
Further out, five-year, five-year HICP has just kept range trading. It touched about $2.08 at the end of June, the lowest since the whole US-Iran episode began, and it's marginally cheap on a six-month regression. But honestly, we'd expect it to stay in that $2.10 to $2.20 band.
One more thing I'd flag is in French inflation compared to HICP. The five-year, five-year FCPI versus HICP spread has narrowed sharply since the start of July to around minus five basis points, which is close to the tightest we've seen it in, like, 10 years. This has, like, only happened a handful of times in that time.
A lot of it is the ongoing weakness in Liberia flows, and with the rate reset at a still low 1.7, we don't see much of a turnaround in the flows as a result. So it's not that the support is coming from higher hedging needs, but at these kind of historically tight levels, we do think there's scope for that spread to unwind some of the tightening and drift back towards positive territory over time. Thanks, Frida.
Interesting to see such tights in the midst of an energy shock. Let's cross the channel. The UK has been caught up in the same energy move, hasn't it?
What's the picture at the front end? It really has. So front-end RPI has risen by over 20 basis points in the last month, and it's outperformed on the curve, just like we've seen in front-end HICP and in US CPI.
And the driver is the same. It's energy volatility on the back of the tensions in the Gulf of Hormuz and uncertainty over how durable the MOU actually is. UK natural gas has climbed over the past couple of weeks, though.
The front contract is now at its highest level since early April, and gas futures right across the curve are still sitting well above where they were before all of this started, back at the end of February. On the forecast side, we have headline CPI rising a little over 3% in the fourth quarter, with a peak closer to 3.5 in early 2027, and a core moving up close to 3% over the autumn. What's interesting, though, and it mirrors the euro area, is that oil isn't really the main driver of the front-end here anymore.
Even with the pick-up in hostilities, front-end RPI sensitivity to Brent has stayed low, and the rolling 60-day R-square is back down to pre-conflict levels. So front-end RPI is now sitting around 3.75, though it's swung around in a wide, roughly like 40 basis point range over the past three months. If anything, current levels for one-year, one-year RPI look a little bit elevated versus our forecast for RPI, Brent's to hold towards 3% by mid-2028, and on a relative value basis, it screens about 12 basis points reach versus nominal yields, and once you adjust for energy.
But that richness looks justified to us because it's reflecting the higher risk premia around the conflict and elevated uncertainty in oil and gas prices. And across the rest of the curve, the intermediate sector, long-end, real yields, how does that all look? In the intermediate sector, five-year, five-year RPI is at 3%, close to the lows for the year, and it screens about eight basis points cheap versus a basket of drivers.
But that cheapness is a bit of a marriage because it's really about decoupling from nominal yields. Five-year, five-year RPI has ranged traded just below 3%, even as five-year, five-year Sonia sold off back above 4.80%. That decoupling explains most of the optical cheapness, so we're inclined to look through it rather than call it a genuine value.
The long-end is more interesting, to be honest. The five-year, five-year, 15-year, 15-year RPI curve is close to its steepest in several years, and given the empirical convexity of that curve, we think the risks are skewed towards flattening. A rally in the very long forwards shouldn't steepen the curve much, but it should flatten if those long forwards drift towards 3%.
And then there's real yields. Ten-year real yield swaps are around 130%, so roughly 20 basis points cheaper over the past month, and about 20 basis points cheap versus the Sonia curve once you adjust for the Bank of England's APF holdings, which is the largest relative cheapness in summer. So we're constructive there, and we think they can rally something like 25 to 30 basis points for three reasons.
First, valuations are just attractive, both outright and relative. Second, even with higher oil volatility, we see limited scope for a big sell-off in front-end yields. And third, over the long run, we think UK trend growth is unlikely to run above 1% given limited productivity growth, and that should anchor real yields.
Andy Burnham was announced as a PM last week, and whilst we think it's too early for intermediate whilst we think it's too early for intermediate real yields to reflect any increased uncertainty from any fiscal policy changes, we do think uncertainty could increase closer to an autumn budget, and that could eventually put some cheapening pressure on 10-year real yields later this year. High real yields is definitely something we're seeing here in the US, but across what you've said, it seems like we're seeing similar cross-currents globally. Probably yes.
Across the euro area, the UK and the US, the common thread is the same. The energy re-escalation and higher gas prices in particular has pushed front-end break-evens back up and kept the inflation curve flat to inverted, while intermediate break-evens have been much better anchored. Perfect.
That's a good place to end it. That's all from us. Thank you for listening.
Stay tuned for more updates on the fixed income space here at the At Any Rate JP Morgan's Global Research Podcast series. This communication is provided for information purposes only. Please read the JP Morgan research reports related to its contents.
For more information, including important disclosures, copyright 2026, JP Morgan Chase & Co. All rights reserved. This episode was recorded on the 20th of July, 2026.