OPTIONS: More Upside In Rates, Including An ECB Cutting Play

Monday's Europe rates/bond options flow included:

• OEM5 116.00/117.75/117.25/118.75 put condor vs. 120.00/121.50 call spread, paper sells the put condor, buys the call spread for 32 on 13.5K.
• RXN5 132.00/133.50 call spread paper paid 20 on 3K
• SFIM5 95.90/96.00/96.10 call fly, paper pays 1 for 5k
• SFIU5 96.15/96.35/96.55 call fly paper paid 2.75 on 5K
• SFIU5 96.00/96.10 call spread sold at 5 in 8k
• SFIZ5 96.20/96.30 call spread vs. SFIZ5 95.75 puts, paper bought the call spread to sell the puts, paying 0.5 on 4K.
   

• Much of the EU and German fiscal push over the past two and a half months has been in defense spending and infrastructure investment with longer-term horizons.
• There have been increasing question marks over the extent to which this fiscal support will be inflationary, with 5Y5Y EUR CPI swaps holding most of the reversal from their initial spike higher on the early March announcements. Indeed, US-EU inflation swap differentials have at +38bps have fully reversed the initial drop to as low as +17bps. 

• US market-based inflation expectations remain a story of one where short-term elevated expectations on the back of US tariff policy aren’t spilling over to longer duration measures, even when comparing just 1Y vs 1Y1Y metrics (left chart).
• 1Y inflation swaps have been helped lower by last week’s de-escalation in China-US trade policy, and at 3.24% today are below the 3.25% seen the day before Apr 2 Liberation Day announcements. They are however still elevated by the standards of the past two and a half years having pushed higher ahead of reciprocal tariffs.
• In contrast, the 1Y1Y inflation swap of 2.525% is back at Apr 1 levels. That’s high compared to pre-pandemic levels averaging closer to 2% but it’s very much in line with recent averages away from the 2021-22 peak of the post-pandemic inflation episode.
• With FOMC participants frequently talking on the need to keep inflation expectations anchored, this should continue to please them.
• Looking cross country, the opposite is true in Europe where negative near-term growth implications of US trade policy are deemed most acute.
• 1Y EUR inflation swaps at 1.43% are ~25bp lower than pre-Liberation Day levels and ~50bp lower than late March levels (right chart). The 1Y1Y at 1.75% meanwhile is 12bp and 14bp lower respectively.