Global Rates: Sovereign spreads, euro area rate vol and UK rates into the Budget
The market appears to be recalibrating its views on Euro area sovereign spreads and UK interest rates as we approach the upcoming budgetary measures. Per the full note by J.P. Morgan Global Research, the discussions among analysts highlight growing volatility expectations particularly in the euro area, which could affect currency positioning. Additionally, indicators suggest potential shifts in UK rates, driven by fiscal policy adjustments. Observations indicate that sovereign spreads are tightening, aligning with a broader narrative of monetary policy normalization.
What the desk is arguing
The desk believes that current dynamics in Euro area sovereign spreads and UK rates could set the stage for increased volatility in FX markets. Per the full note , analysts are eyeing these movements closely as fiscal policy announcements may influence interest rates and economic outlooks.
Notably, sovereign spreads have shown a tightening pattern, with potential implications for currency pairs like EUR/USD. Analysts from J.P. Morgan highlighted this trend in their assessment, pointing to a general market sentiment that is increasingly cautious yet optimistic about fiscal reforms.
The alternative read would suggest that sustained global economic uncertainties could counteract these potential gains, leading to a different market response than currently anticipated.
01Euro area sovereign spreads are tightening, indicating potential for increased market volatility.
02UK fiscal policy adjustments may influence rate expectations significantly.
03The upcoming budget is likely to drive short-term market reactions and adjustments in positioning.
04Market sentiment is increasingly cautious, shaped by the context of broader economic uncertainties.
Market implications
Traders should watch for significant break levels around 1.075 in EUR/USD, which could signal a shift based on the new fiscal policies. The forthcoming budget announcements are likely to provide additional clarity and market direction.
Risks to this view
A major risk factor includes any unforeseen shifts in global economic conditions that could reverse current trends in sovereign spreads and rates. Should the fiscal measures fail to inspire confidence, expect a swift market recalibration.
Hi, and welcome to At Any Rate, JPMorgan's global research podcast series, 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 Francis Diamond, Head of European Rate Strategy at JPMorgan. And today I'm joined by my colleagues Aditi Chaudhary and Kendrick Gupta to discuss sovereign spreads in Europe, rates volatility, and some thoughts on UK rate markets into the budget.
So DM yields are lower over the past week, and mainly it's been led by treasuries reflecting some growing concerns over recent days over AIH valuations, while sovereign spreads in Europe have stabilised and modestly tightened as a technical and positioning backdrop, particularly in France, has improved. So Aditi, how do you interpret the dynamics in sovereign spreads this week? It looks like Germany stabilised around about 140 basis points, I think this is now a new steady state level.
And what about Italian spreads? So thanks, Francis. So indeed, as I mentioned, like intramural spreads have stabilised over the past two weeks.
Although we do have some intermittent choppiness, especially in France, but given the moves we saw the sharp widening during late August, late September, early October, I think clearly the spreads have found a new steady stabilisation level at the time being. And what, as I highlighted in the previous podcast, like the widening pressure through late summer into, let's say, early October, which we saw among the weaker sovereign credits, so I'm here, let's say, France was the main one, but Italy, Greece and Belgium also widened in my space. And we have attributed this pattern to a combination of resilient regional growth, which in turn led to a sharp rise in yields along with the higher energy prices, and also elevated volatility, which disproportionately deteriorated the debt dynamics for the high debt issuers.
And then on top of it, we had the renewed caution on France amid expectation of choppy political news flow. We had the budget slippages for 2026, the 2027 budget announcement, and ongoing chatter around the 2027 presidential election. Overall, as we discussed last time, there's not much new news over the past two months to warrant such moves.
But clearly, the noise in an already uncertain period was adding to the widening move. And finally, and I think that's the one which I stressed last time, is the technical imposition in headwinds, which were the key there, especially during the last week of the widening, the last week of September, we saw. And somehow, like this week, we are able to look at through the data, which over the period, and the technical washout nature or interpretation is getting much more clearer when we look at, let's say, example, the yield versus spread relationship, which has evolved in a way, like, which clearly points that the late September, a good part was about technical washout.
So what I'm trying to say here is that, like, the spread sensitivity to higher debt sovereigns or to the level of yields has been rising through late September. So as the yields were increasing, the high debt sovereigns were the ones which were widening the most, which, as I discussed above, was more about increasing that systemic, not concerns or necessity, but challenges or increasing costs for the higher debt countries because of the higher interest rate. So it disproportionately impacts them.
And that relationship sort of weakened dramatically around late September, because at that time, we saw German yields or even ECB type expectations getting eased, while the French spreads were widening aggressively. And that is consistent in our view with positioning or technical drivers temporarily dominating the fundamentals. And then, over the recent weeks, especially over this week, the direction has appeared to reassert itself in the sense that we have seen intra-immune spreads, especially even the French spreads, tighten alongside yield rally.
And the rally over this week, as you also mentioned before, like, globally was driven by a bit more risk of nature around the AI equity valuations, those type of concerns. And even in those risk of episodes, the intra-immune spreads and the French spreads were able to tighten as the yields were rallying. So that re-strengthening of the yield sensitivity suggests that the most acute technical pressures are behind us, and earlier dislocations have likely faded.
So leaving spreads, once again, more responsible to broad rate moves. So I think the technical picture is much more cleaner now. I think positioning, the sense we get anecdotally, is still heavy at the front end, but feels like it might be in a much more stronger or stable hands in France.
So in France, as you mentioned, it's just a new steady state. We still find the levels maybe a bit cheap, even when we look at different valuation frameworks and apply some judgment on the political discount that should be priced. But we believe that the ongoing risk of political noise, along with still elevated global risk for volatility, will keep investors a bit more cautious on France, despite these attractive valuations.
But even if there is room for 10, 20 basis points, from 140, we go closer to 110, 110 basis points, 120 basis points level. That's what we have in our forecast. But it might be much more gradual.
It might take a bit more stabilization before that thing is realized. Whereas, we can start seeing some gradual normalization in other infirmary spreads, as these technical stress periods behind us, and we see more stabilization. So those spreads who did widen along with France around that period of late September are looking quite attractive.
For example, Italy is now screening quite wide versus Euro ID credit. So there could be quite interesting opportunities on those fronts. Okay.
Thank you. That's very helpful, very clear. So let's maybe focus a bit about volatility in Europe.
So Kigendre, implied vol has exhibited itself quite decent volatility and sits towards the upper quartile of recent ranges. So where do you think volatility can go from here? And are there any side effects from this high volatility regime or any interesting observations you've seen?
Thanks, Francis. Yes, you know, it has been a while since we have talked about, talked explicitly about rates volatility in this podcast. So it's good to touch base on that.
As you mentioned, vol of all has been rather high over the past few weeks. So Euro rates implied have come off their recent highs. These highs were observed during the peak of the entry of the spread widening episode a couple of weeks ago that I was just mentioning a few seconds ago.
But vol, like implied, still remain well above the June-August averages. So overall, in my view, they remain elevated and I expect them to gradually decline over the coming weeks. Now, interestingly, there has been a decent steepening of the volatility curve across tails.
For example, you know, 30-year vol is richening relative to 2-year vol. The curve itself is inverted, but it is becoming less and less inverted over the last few days. This richening of long-end versus short-end is uncharacteristic of a period in which central banks are actively changing policy rates.
Now, however, in my mind, it also points to the fact that front-end yields are likely anchored around current levels and thus volatility will gradually shift outwards. In our weekly publication this week, we discussed that the range for front-end yield, let's say one-year ester, has been tightening and the two-week range for one-year one-year is now close to the Y2D lows. Now, it remains to be seen whether these tight ranges will compress further, but I believe that there are limited near-term catalysts to push terminal rate pricing significantly away from current levels.
We have noticed that the sensitivity of red ester to energy crisis has broadly been non-existent over the past month, and this has been instrumental in keeping terminal rate pricing around, let's say, centered around 320, so 315 to 325 range over the last few days. For me, this tightening of ranges is interesting and should lead to further compression in implied vol over the near-term. Now, however, I still think that outright short gamma exposures are too risky, jump risk is high, and thus could temper short gamma returns.
Now, instead, we like what we call as range trading strategies, such as short unedged straddles at the front end, which offers wide break-even ranges as implied are still currently elevated. And so, we expect these kind of trades to benefit from both from implied declining and yields staying in a tight range. Now, an alternate expression of this limited expectation of tight range could also be done via short spread narrowers, which will also benefit, in my view, if front-end yields stay in a tight range, vols decline further, and as Aditya was mentioning, peripheral OAT boon spreads kind of hover around current levels or as they gradually tighten over the coming weeks.
Now, you also mentioned briefly about any interesting side effects of this high vol regime. There are several, but let me focus on two such interesting observations. First, overall increase in long-end yields.
And by this, I'm not just talking about the rise of the volatility in the last couple of weeks, but I'm talking about the persistent increase in long-end yields over the past several months. Now, that, coupled with increase in volatility, has increased the CTD switch risk in Boxel and OAT futures. We find Boxel basis to be rich at current levels, and in our view, our current market pricing of the basis is consistent with too high levels of volatility.
And basically, it is consistent with vols that was like there in late September, early October. Thus, as in my mind, yields stabilize around current, around here, and over the near term, vols also decline, Boxel futures should reach in relative to the current CTD. Second, we also recently published a note discussing the impact of vol on money market futures convexity.
Now, I don't think this is the right time to explain the workings or the fundamentals of futures convexity, and I would encourage our listeners to read my recent note on futures convexity. Just to summarize here, futures convexity is directly related to volatility, and under current high vol environment, these have been pushed higher relative to historical averages. The estimate of this convexity will depend on the vol assumptions one makes.
For example, if I use a recent delivered vol, let's say the 4Q29 Eribor futures have a convexity number of somewhere around three basis points, which will jump to somewhere around five to six basis points if we use implied vol as our measure of vol instead. So, I mean, it is critical what vol assumptions we make. More importantly, these convexity adjustments could have impact on the fair value estimation of futures, and also downstream calculations such as carry, for instance.
So, these are my main observations for vol. Now, Francis, let's shift focus to the UK. The UK budget is less than two weeks away, but the messaging from government appears to suggest that there will be no big surprises, and UK rates market aren't pricing any budget-driven fiscal risk premium.
Is this your reading as well? Yes, I pretty clearly agree with that assessment. I mean, I think the sense we have here is the budget at the end of the month will be fiscally neutral.
I mean, as you say, it looks like most of the media reports suggest there'll be no significant fiscal policy changes. There'll be some small, limited tax increases, and they'll be targeted to pay for some modest cost-of-living support measures. And if we wind back to Prime Minister Burnham's Labour Party conference speech at the end of last month, I mean, I think that also supports the narrative, given a lot of the discussion he kind of put there on the pre-sizeable policy changes were very long-term focus, so social care, electoral reform, the UK's relationship with the EU.
Overall sort of policy options for several years down the road, not anything that seems to be imminently in terms of affecting fiscal dynamics in the next year or two. So there's also got to focus on headroom in market space. I mean, clearly the rise in yields probably meant the fiscal headroom on the forecut from the budget in March is high, and from, let's say, just over 23 billion to around about 12 billion.
But this is really reflecting global drivers, higher energy prices as a result of the US-Iran war, rather than any UK idiosyncratic factors. And it's worth remembering this fiscal headroom is designed to be a buffer against adverse shocks in terms of what they do to the forecast themselves. And I think given this and this global nature, there isn't really a huge need for the Chancellor to fully rebuild that headroom back to prior levels.
So our assumption is it will modestly be increased to around about 15 billion. Maybe we see some small 3, 4, 5 billion increase in taxes, a small portion left over to fund, as I said, targeted cost of living related spending measures. And this seems pretty much in line with rate market expectations as well.
So I mean, given our view that this sort of modest rebuild, no big changes to fiscal policy, there's no obvious sense that the budget will reaffirm the fiscal rules. The Chancellor won't sort of go down the route of talking about flexibility. And we're not going to see any large increases in borrowing to fund any fiscal policy changes.
I just don't think we really should be expecting UK rate markets to price in any increased fiscal term premium over the coming weeks. I mean, like you said, to start there in the question, there's not a lot of obvious risk premium price. So if we look at 10-year gilt bund spreads, yes, 10-year gilt yields are roughly 80 basis points higher since March and the spring statement.
But a lot of this reflects the repricing of BOE rate hike expectations. And as I said, if you cross-market 10-year gilt bund spread, it really is very clearly tracking market pricing and relative central bank expectations, i.e. BOE tightening versus ECB tightening.
And that 10-year gilt bund spread looks pretty much fair value when we adjust for relative money market spread, such as 1-year 1-year Sonia versus 1-year 1-year Esther. And it's the same story for the curve. If you look at Tuesday's 10-year gilt curve, it's been flattening over the past few weeks.
However, the main drivers, as they have been for the past several months or so, is really the level of front-end rates and the shape of the dollar curve. And when we adjust for those factors, Tuesday's 10-year curve looks very much in line versus those drivers. So I think this dynamic remains.
I don't expect outright level of yields or cross-market 10-year gilt bund spread or the shape of the Tuesday's 10-year gilt curve to really change in terms of pricing any shifts in fiscal risk premium or UK uncertainty around fiscal dynamics over the coming weeks into the budget. So, thank you, Aditya. Thank you, Guyendra.
That's all from us. And thank you for listening. Stay tuned for more updates on fixed income space here on At Any Rates, Jay Paul's global research podcast series.
This communication is provided for information purposes only. Please read Jake Morgan research reports related to his content for more information, including important disclosures. Copyright 2026, Jake Morgan Chase Co.
All Rights Reserved. This episode was recorded on 16th October 2026.