Gas and oil bull-flatten; Short helps auction
Front end inflation re-priced again today as another double-digit rise in gas futures on the back of supply limits combined with choppy trading in oil (Brent futures hit $107 this morning but were back to $104.5 shortly after the close) to leave EUR 1y swaps around 18.5bps higher at 6.625% while 5y rose 7.25bps to 2.8275% as the curve bull-flattened.
Dealers suggested that the momentum/volatility of energy would continue to provide support to inflation despite the late session fall in oil today. They added that the upcoming HICPx fixing was well-bid in the brokers ahead of the data for July, which kicks off with German inflation on Thursday.
Energy price risk was also seen as a factor in today’s overbid Italian linker auction. The Treasury sold €500m of the BTPei-41 with bid to cover of 2.09 along with €750m of the BTPei-22 with bid to cover of 1.84. A Street short and confirmation yesterday that the August 25 BTPei auctions would be cancelled also helped demand, traders said.
Indeed, although clients are still at the their desks this week, dealers said that liquidity was not great even before the August getaway, with the risk of a hawkish FOMC meeting this week seen by some as a threat to the 10y area of the inflation curve.
Meanwhile the flattening of the inflation curve today meant that EUR 5y5y ended a touch lower at 2.0575% even as EUR 10y rose to 2.4425% (+3.5bps). The Total Derivatives SDR shows mostly EUR 5y and 10y trading, although EUR 8y went through during the afternoon at 2.5325% in €56m.
Finally, FRF inflation swaps underperformed EUR a touch at the front end but FRF-EUR 10y was little-changed at around 33.5bps and traders today tended to play down the lasting impact of any further unilateral measures by the French government over the Summer to reduce the impact of higher energy costs on consumers.
Inflation outlook: Banks
In the research, banks preview upcoming inflation data and attempt to gauge the extent of underlying inflationary pressures in the Eurozone.
Barclays forecasts euro flash inflation at 8.8% and looks for food and services inflation to “continue grinding higher”, while energy and non-energy goods could send “mixed” signals. The bank explains:
- “Inflation will likely show a continuation of input-cost driven inflation, especially in food and services components where robust consumer demand has allowed firms to protect or even raise profit margins in the current reflationary environment…At the country level we expect inflation to ease in Germany1 (8.1% y/y; -0.1pp) but strengthen in France (6.7% y/y; +0.2pp), Italy (8.7% y/y; +0.2pp) and Spain (10.6% y/y; +0.6pp).”
Anecdotal evidence of inflationary pressures continues to arrive, most recently after consumer product behemoth Unilever said today that it had raised its prices by 11.2% over the three months to end June due to higher input costs even in the face of a 2.1% drop in sales, according to the FT. Further down the supply chain Walmart reported that higher (US) inflation was hitting consumer demand but also pushing up inventories, leading the chain to markdown some lines.
Elsewhere, JP Morgan attempts to assess the strength of ‘underlying’ inflation using various measures of “core” inflation and/or by isolating pandemic driven areas of the HICP.
- “Weaker growth could contribute to the easing in inflationary pressures (but) it is also important to consider how much of a medium-term inflation problem has already built up.”
“Measures have been developed to measure ‘underlying’ inflation. Most of these have picked up strongly, but are in our view not designed to deal with the current situation. In particular, they are not focused on controlling for the influence from pandemic-related re-openings, pass-through from the surge in energy prices and supply bottlenecks.”
“…(Such measures include) supercore, trimmed means, weighted medians, principal common components, diffusion indices and low-import content inflation. What these measures have in common is that they are all at elevated levels and point to broadly-based inflation pressures.”
“(However) We have gone through the entire services basket and excluded items that are very likely impacted by the pandemic. The inflation rate of pandemic-related items is very high at 6.9%oya in June, even though it includes large drag in June from Germany’s €9 public transport ticket…In contrast, the inflation rate of non-pandemic items is much lower at barely above 2%oya and has increased only very gradually in recent months”.
“…Unless energy prices keep rising into the medium-term, the inflation rate of the energy-related core items should eventually moderate once the higher energy prices has passed through… On the core goods side, price pressures are much more broad-based, likely reflecting high demand during the pandemic, supply bottlenecks and energy cost effects. We note, however, that the pre-pandemic norm for core goods inflation was 0.5%-1%oya, which gives room for services inflation to run a bit above 2%.”