Rates Spark: Testing new highs
Lead — As oil prices extend their upward trend, the 2Y EUR swap rate has tested critical levels above 3%, reflecting a hawkish sentiment that the European Central Bank (ECB) may maintain its tightening stance. Per the full note from ING, while economic recovery in the eurozone is encouraging, concerns remain about the fragility of this growth, heightened by geopolitical uncertainties in the Middle East. The sharp increase in UK gilt yields further complicates matters, stirring caution among investors. Currently, market consensus positions EUR/USD at 1.1434, which is below several firms' targets, indicating expectations of a stronger euro in the medium term.
What the desk is arguing
The desk frames this as an environment where rising oil prices are driving short-term interest rates higher, thus providing the ECB with more flexibility to adjust its policy stance. With the 2Y EUR swap rate breaching 3%, the implications for monetary policy cannot be understated, particularly in light of the economic recovery narrative that has emerged alongside higher oil prices.
Supporting evidence includes the fact that while forward-looking surveys are yet to reflect the latest changes in oil prices, they will be crucial for assessing the resilience of growth in the eurozone. The relative calm in implied rate volatility further suggests that markets may not be pricing in an immediate escalation of risks, despite the tensions in the Middle East.
Where it sits in our coverage
In terms of our internal consensus, the current median target for EUR/USD stands at 1.16, ranging between 1.12 and 1.20 by Dec-26. Noteworthy targets include: - bofa: Mar26 1.1700, Dec26 1.1500 - goldman: Mar26 1.1800, Dec26 1.1200 - mufg: Mar26 1.1800, Dec26 1.2000
This view aligns closely with many firms in our coverage, particularly goldman, which sees a target of 1.1800 for Mar-26, suggesting that our desk's projection is within the higher end of the current spread.
How other firms see it
Aligned firms are largely forecasting higher targets for EUR/USD, as seen from goldman and mufg. Contrarily, firms such as citi and bofa appear more cautious, predicting lower movements.
The trajectory of EUR/USD does parallel concerns around ECB's potential policy shifts and inflationary pressures from rising oil prices, making it essential to monitor these developments closely. Additionally, watch the GBP/USD path as UK fiscal policy under new leadership influences market sentiment.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Rising oil prices are impacting short-term interest rates, with the 2Y EUR swap rate above 3%.
- 02The ECB may retain a hawkish stance, supported by a recovering economy, yet growth remains fragile.
- 03Current EUR/USD consensus is at 1.16 Dec-26 target, lower than many expected firm forecasts.
- 04UK gilt movements under new leadership may influence broader market sentiment.
Market implications
Traders should watch for potential EUR/USD moves towards 1.1600 as firms align with a stronger euro narrative. The upcoming fiscal policy decisions in the UK could also provide further guidance on GBP-related trades.
Risks to this view
Should geopolitical tensions escalate significantly or if oil prices stabilize below current levels, it may force the ECB to reconsider its hawkish approach, potentially reversing the bullish sentiment around the euro.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
Bank of America | Bullish | 1.1500 |
HSBC | Bearish | 1.1000 |
Scotiabank | Bearish | 1.1200 |
Articles Rates Spark: Testing new highs Published 08:12 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download As oil prices push higher again, the 2Y EUR swap rate has tested levels above 3%. Implied rate volatility remains more contained as the risk of a severe re-escalation in the Middle East still seems unlikely. Meanwhile, the 10Y gilt yield has broken through the 5% mark amid increased fiscal uncertainty following Andy Burnham's appointment as prime minister Michiel Tukker With oil above $90/bbl, the 2Y euro swap rate is at record highs as in March Oil still driving rates, but future outcomes have narrowed Oil has been testing prices above $90 per barrel again and at the same time, the 2Y euro swap rate has touched 3%, matching the record high reached in March.
Rates can take this hawkish view because the growth picture continues to recover, giving the European Central Bank more room to react without worrying about negative economic consequences. Having said that, the growth outlook for the eurozone remains fragile. Forward-looking surveys such as July’s ZEW will help us understand whether the recovery remains resilient given the latest re-escalation in the Middle East.
Unfortunately, July’s data won’t incorporate the latest jump in oil yet. Another key difference compared to March is that implied rate volatility remains much lower. While uncertainty around oil prices has risen again, the tail risk of oil moving far above $100 has declined.
Since March, Iran and the US have shown greater willingness to resolve the conflict. From the US perspective, a further surge in oil prices would likely be politically unpopular. As such, the range of possible ECB policy rate paths has narrowed alongside oil.
Gilt investors getting more nervous as fiscal language loosens Meanwhile,10Y gilt yields jumped above 5% on potentially more fiscal spending under new UK Prime Minister Andy Burnham than is currently priced in. Compared to peers, sterling rates remain elevated, and while that is mostly an inflation story, the political risk premium also seems to be rising. We now estimate that the risk premium for 10Y gilts is close to 20bp, which is a few basis points short of the risk premium preceding last year’s Autumn Budget.
In practice, that means there still is some upside, especially if Labour wants to test the flexibility of financial markets. Here you can read about the potential policies we could see from Burnham. Expect more volatility in coming days as new policy ideas are floated in the media.
Tuesday’s events and market view After UK employment figures came in broadly as expected in the morning, we have the ECB bank lending survey. While usually not a market driver, these figures are used by the ECB to assess financial conditions. Afterwards, we get July's ZEW survey outcomes for Germany and the eurozone.
Sources & References
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