USDi: BEs continue to leak lower amid ongoing risk-off trade

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BEs continue to leak lower amid ongoing risk-off trade

Another bad day for risk sentiment (Dow -1.03%, S&P -1.44%, Nasdaq -2%) as market participants continued to come to terms with the most recent rounds of sobering (i.e. better-than-expected) data combined with a another bad day in the energy trading pits (gasoline -2.21%, Brent -3.70%, WTI -3.33%) wreaked havoc on an already skittish U.S. inflation asset class today. 

To be sure, right on the heels of yesterday’s compression in TIPS breakevens and inflation swaps, the asset class was offered down even more aggressively today as the inflation curves were marked down another 6-11bps in another bear steepening move.  And this came against the backdrop of a initially relatively tame and tightly coiled intraday trade in nominals before an afternoon gap higher that left yields up to 5bps lower at the outperforming long-end of the curve.

“Risk-off mood combined with some big unwinds and liquidation rinsed the breakevens today in a continuation of what we have seen yesterday afternoon with no buyer to fade and fight this trend,” one dealer explained.

Flow-wise, in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 268bps, 267bps and 266bps, 10y ZC swaps at 262.25bps, 25y ZC swaps at 250bps and 246.875bps, and 30y ZC swaps at 238.375bps (for more trades, see Total Derivatives SDR).

Heading into the 5pm close, the 2y breakeven in going out at 242.625bps (-10.25bps), 5y at 243.75bps (-8.375bps), 10y at 233pbs (-7.875bps) and 30y at 238.125bps (-7bps).

USD real yields versus EUR real yields: Banks

Analysts at Deutsche Bank have previously suggested UST outperformance and a spread tightener as a favored trade for 2023 (see Total Derivatives). Now they explain why DB sees tightening in the real rate spread – currently around 165.5bps on a simple basis with 10y TIPS at 1.205% and 10y Bundei at -0.45% - as an key driver for that, given that the 5y5y USD-EUR inflation spread is already narrow.

“Interestingly, the USD-EUR 5y5y breakeven differential is at its historical tights if one excludes the immediate aftermath of the GFC. This is consistent with our economists' assessment that core inflation is likely to be relatively more sticky in Europe. It also implies that the Treasury - Bund tightening we anticipate should be largely driven by the real rate differential.”

Elsewhere, BofA also likes USD real rates and/or real rate tighteners:

“We are constructive (USD) real rates on the expectations of: (1) economic downturn, which will see back end real rates drop; (2) sticky inflation, which should be positive for carry and skew risk towards higher breakevens on a premature Fed pivot.”

 

“US real yields offer value both outright and cross-market - real yields should drop materially if our economists are right, and EUR rates look too expensive cross market in a global bond market rally.”

 

“Walue resides at the long end, where we favour TIPS in real yield terms, on both an outright basis and versus euro linkers.”