The desk's thesis emphasizes a mix of widening cross-currency bases driven by the evolving interest rate expectations in the Eurozone and the US. Per the full note from J.P. Morgan Global Research, the dynamics of the €STR/SOFR basis are pivotal as they illustrate the relationship between the euro and dollar. Current shifts in positions appear noteworthy, as traders anticipate further Fed dovishness and ECB adjustments mid-2026, likely impacting cross-currency spreads significantly.
What the desk is arguing
The desk asserts that the interplay between €STR and SOFR cross-currency bases will significantly shape EUR/USD valuations moving into late 2025 and beyond. Recent discussions by J.P. Morgan highlight how interest rate differentials are likely to widen the basis and consequently influence trading positions on the pair.
Furthermore, it is critical for dealers to note that positioning adjusts with the expectation of ECB policy persisting amid Fed dovish narratives. The trends observed in the bases suggest a pronounced sensitivity to shifts in monetary policy that may profoundly reshape spot values.
Where it sits in our coverage
For our EUR/USD coverage, the current consensus target sits at 1.1700, with a range spanning from 1.1200 to 1.2000. Significant targets from selected institutions include: - morganstanley: Mar26 1.2000 - deutschebank: Jun26 1.2000 - jpmorgan: Mar26 1.1800
This viewpoint aligns closely with jpmorgan and others at the higher end of this spectrum, indicating strong bullish sentiment towards the euro against the dollar in the medium term.
How other firms see it
Several firms echo the desk's outlook, with notable bullish sentiments from morganstanley, targeting 1.2000 by March 2026, which bolsters an aligned growth perspective. In contrast, citi trades at a more cautious stance at 1.3200 for the same tenor, highlighting a divergence in sentiment.
Important to note, the EUR/USD trajectory mirrors ECB's rate path, emphasizing the interconnectedness of these economic indicators as traders position for changing monetary winds.
02Interest rate expectations are pivotal in driving trade positioning through 2026.
03Consensus targets show bullish sentiment reflecting the strength of the euro.
04Monetary policies from ECB and Fed significantly influence market outlook.
Market implications
Watch for the EUR/USD to react to further monetary guidance from the ECB, especially as the consensus target indicates a potential rally. The current spot at 1.1466 positions traders for a breakout towards 1.1700, contingent on favorable signals from European rate adjustments.
Risks to this view
A misstep in ECB communications or unexpected Fed hawkishness could invalidate the bullish EUR/USD stance, leading to significant reversals in positioning and market sentiment.
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 Kagendra Gupta, head of European Interest Rate Derivative Strategy at J.P.
Morgan. And today I'm joined by my colleague, Ipek, head of U.S. Interest Rate Derivative Strategy, to discuss the drivers and outlook for Fed policy and balance sheet expectations, along with drivers and outlook for the Aster Sofer cross-currency basis.
We are recording this podcast on October 3rd, and our comments today are based on our published research available on J.P. Morgan Markets. Let me begin by a top-down analysis of global DM cross-currency basis.
So over the summer months, DM cross-currency bases have generally moved in a small range, with some cross-country divergences. Now, indeed, a PCA analysis across various DM bases shows that the first principal component analysis factor explains around 80% of the total variance at the front end. And this explanatory power jumps to around 90-plus percentage for, say, at the five-year point on the curve.
This basically shows that globally cross-currency basis tends to move in unison to a large extent. Of course, there are divergences as well. For instance, diverging monetary policy or dynamics around cross-border issuances could have some local dislocations.
Our analysis shows that for the most part, the Aster Sofer basis has been driven by evolution of relative monetary policies of the Fed versus the ECB, in addition to other idiosyncratic factors such as cross-border issuance, etc. Ipek, let me start with asking you about the Fed. The Sofer curve is now in about 45 basis point of cuts by year end, and a cumulative around 110 basis point by end of next year.
Do you think this is fair given how inflation and labor markets have evolved? I ask this because evolution of this pricing will likely be the most significant driver of the Aster Sofer basis. Yeah, so thanks, Karendra.
And that's definitely an important point to address. And currently, what's priced in by the markets for this year is fairly in line with what we have penciled in. So, we are currently looking for two more cuts.
And as you said, the markets have 45 basis points. But when we turn to next year, it appears that there's too much easing that's priced in. So, we are looking for just one more cut next year versus the markets that have, call it, three more cuts.
So, turning to this year, that's probably fair, right? Given the labor market concerns and Chair Powell's comments and the FOMC statement, we will likely see more cuts this year. But we can't ignore the risks to inflation, which is why we only have one cut next year.
And also, we had the FOMC meeting last week. And if we were to look at the so-called Fed dots, the median dot for the out years was just another cut in each of the next two years, which would bring the rates to a new neutral of, call it, 3.125. So, all of this to say, it does appear that there's too much easing priced in versus next year versus our expectation.
Okay. So, too much is priced in. I agree with that.
And when I combine this view on the ECB, which is broadly fair, it seems that this factor alone, the Esther Sofer basis is, on this factor alone, the basis is biased more negative. Okay. That's glad to know.
Now, what about the Fed's balance sheet? The ECB is on an autopilot mode. Where do you see Fed's balance sheet going over the coming quarters?
Yes. So, the Fed's balance sheet has also been in autopilot mode. They did make a minor change in March, where they made an adjustment to the runoff schedule and they capped the treasury runoff at $5 billion.
And this was likely preemptive of any potential funding pressures when we had the debt ceiling resolution that was still not done when the Fed made this change. But currently, everything appears to be moving steadily. We have the Fed's balance sheet declining at roughly $20 billion per month.
And TGA, that's treasury general account, that's back to, call it normal levels, around $800 billion. And one interesting development in the past few months is that the overnet RRP facility has declined to around $15 billion, which is very, very small. While reserves have continued to hold steady, and we still have over $3 trillion of reserves on Fed's balance sheet.
All this to say, with the current pace of QT and amount of reserves, we think QT can continue for a bit longer, at least to 1Q26. But if we get through major funding days, like the corporate tax day and the quarter end without a hitch like we did this month, there could also be a risk that QT can go on longer. Okay.
And finally, can you also please elaborate a bit on funding markets? Are we to expect any funding pressure over the coming weeks and year end? I mean, you just mentioned that we got through this quarter without any glitch.
So what are your views for the coming future? Yeah, that's right. So, I mean, the past two weeks could have been eventful for funding markets.
So we had the corporate tax day, and now we had quarter end. And at the beginning of September, there was some fear in the markets that, you know, apocalypse from September 2019 could repeat itself. But like I said, that did not materialize.
We went through these two events without a hitch. But, you know, the fact that the funding markets remain orderly, and that there was minimal standing repo facility usage could point to the fact that reserves are still abundant. So now, when we look ahead, we would expect the funding conditions to be relatively soft, or I guess like softer.
And of course, when we get to year end, we could see some funding pressures build up, particularly if banks seek to manage their balance sheets more efficiently for year end. Okay, so maybe let's turn to you, Kagendra. So where do all of these factors take you for the Esther Sofer basis?
You know, when I listened to you to my questions, I think that these seem to be more of like offsetting factors. Like I said earlier, the rate differential metric is supportive of some widening. Although I have to acknowledge that the details of the rate differential to the cross currency basis has been rather small.
On the other hand, in the baseline, relative balance sheet dynamics is supportive of some narrower basis, all else equal. And you also mentioned that we should not worry too much about funding pressures right now. So together, these call for front end basis in my view to remain in a narrow range, but I keep a modest widening bias on basically the rate moves.
Okay, got it. And what about cross border issues? So for issuers deciding between source of funding, should they look to issue in euro or USD?
And do you see like any seasonality of Yankee and reverse Yankee issuances? Yeah, cross border issuance could impart some volatility over the coming weeks. Our analysis using a large universe of relative credit spreads for corporate issuers.
And after adjusting for cross currency basis, we find that it is currently modestly cheaper for them to issue in euro on average, although the attractiveness is rather small. So I don't see a strong bias one way or the other from this factor. You mentioned about seasonality.
So historically, Yankee issuances that is the dollar issuance by European corporates tends to outpace the reverse Yankee issuances in October and November. And repeat of this seasonality would be supportive of basis narrows. Thanks.
And I guess one final question, if you indulge me just a bit more, what about the FX hedging story about investors increasing their short USD hedges, you know, an expectation of a weaker dollar? Is there an impact on the basis from this? Yes, in theory, an increase in short USD hedges by real money investor could exert some widening pressure on the basis because it involves dealing with both spot and forward FX contracts.
So if you are a believer of this story, then you should be biased towards wider basis. From my side, our client conversations tend to broach this topic, but we haven't seen any official data reflecting this dynamic. Of course, this doesn't mean that investors are not reducing their long hedges or adding to their short hedges as these data are generally heavily lagged and dispersed with very low frequency.
For example, our colleagues in Australia note that the Australian super funds equity investment hedge ratios have begun to increase. So probably we will see some more data in the euro area on this over the coming months. So with that, we'll wrap up here.
Thank you, Peck, and thank you to all our listeners. Stay tuned for more updates on the fixed income space here at At Any Rates, J.P. Morgan's global research podcast series.
This communication is provided for information purposes only. Please read the J.P. Morgan research reports related to its contents for more information, including important disclosures.
Copyright 2025, J.P. Morgan Chase & Company, all rights reserved. This episode was recorded on 3rd October 2025.