Euro area data were thin, but early August inflation readings showed headline rates rising to 2.7% y/y in France and 4.5% y/y in Spain as energy, especially motor fuels, picked up. Core inflation fell in both countries, indicating limited second-round effects six months after the Iran war began. Markets have fully priced a 25bp ECB hike in September, while pricing implies almost one additional move thereafter; the note also points to a shift away from expectations for the deposit rate to return to 2.00% in 2027.
In the US, July headline PCE inflation printed at 3.7% y/y versus 3.6% consensus and was unchanged from 3.7% previously, while core PCE came in at 3.3% y/y and 0.2% m/m. Revised Q2 GDP held at 1.5% SAAR but lifted private consumption, imports and the price deflator, and corporate profits rose sharply; yields rose and EUR/USD fell. Germany’s Ifo improved, with the current assessment at 88.5 (87.0 consensus; 86.6 prior) and expectations at 89.1 (87.5 consensus; 86.6 prior). Next week’s focus includes nonfarm payrolls at 65k versus 55k consensus, unemployment at 4.1% and average hourly earnings at 0.3% m/m, alongside euro area HICP at 3.4% y/y (3.0% prior) and core at 2.4% y/y (2.5% prior).
Derivative Strategies for Shifting Eurozone and US Policy Expectations
We recommend that derivative traders position for a dovish turn in Eurozone interest rate expectations after the September meeting. While the swap markets currently price in a 25-basis-point hike for September and lean toward an additional increase later this year, we believe the ECB will pause. Traders can exploit this mispricing by buying December 2026 Euribor futures or entering receiver swaps, anticipating that the second hike will not materialize.
With US Q2 GDP holding steady at 1.5% and PCE inflation edging up to 3.7%, upward pressure on Treasury yields has dragged the EUR/USD down toward the 1.08 level. We expect next week’s non-farm payrolls to print at 65k, ahead of the 55k consensus, which should bolster the US dollar further. Derivative traders should consider buying short-term EUR/USD put options to capture this downside momentum ahead of the labor data release.
Inflation Divergence and Trading Eurozone Yield Curves
Although headline inflation in Spain and France has ticked up due to energy costs, core Eurozone inflation is expected to decline to 2.4% next week. This divergence indicates that the energy price volatility stemming from Middle East tensions earlier this year has failed to trigger second-round inflation effects. As Germany’s manufacturing sector recovers—highlighted by the Ifo index rising to 88.5—traders should look to buy yield-curve flattener options on German Bunds.
Because we no longer expect the ECB to cut the deposit rate back to 2.00% in 2027, long-term rate expectations must be adjusted. Traders should avoid long-dated receiver swaptions that bet on aggressive easing cycles over the next two years. Instead, selling deferred Euribor calendar spreads will allow traders to capitalize on a “higher-for-longer” European interest rate environment.
