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Duration grab-a-thon leaves BEs squishy yet again
Duration – or more precisely the relentless grab for it when it came to nominals – was the name of the game today. To be sure, nominal yields cascaded another 10-14bps lower this session as the market continued to double, triple and quadruple down on (1) less hawkish/slowdown and (2) the recession in 2023 narratives with headlines that Comrade Putin sees increased risk of a nuclear war also fanning the flames today.
And today’s perma-bid in nominals – combined with yet another sharp retreat in those pesky energy prices (gasoline -3%, Brent -2.5%, WTI -2.57%) – made for another day of taking lumps for the U.S. inflation asset class that has re-entered somewhat of a slump of late. To be sure, dealers are marking TIPS breakevens and inflation swaps another 6-9bps lower for the third consecutive session of declines.
Reflecting on some of the recent bearish price action, one dealer explained that “the real yield rally over prior weeks but especially into and out of month-end clearly brought out some sellers.” And given the lack of inflation-specific news until the CPI report next Tuesday, he reckoned that “we will be dependent on the flow dynamic more than ever this week.”
Flow-wise, in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 266bps, 265bps and 263bps, 5y ZC swap at 257.725bps, 7y ZC swaps at 259bps, 10y ZC swap at 255.75bps and 254.5bps, 20y ZC swap at 246bps, and 30y ZC swap at 242.125bps and 241bps.
Heading into the final hour of trade, the 2y breakeven is going out at 238.375bps (-4.375bps), 5y at 237.5bps (-6.625bps), 10y at 227.25bps (-6.25bps) and 30y at 231.5bps (-7bps).
HSBC: Bullish on TIPS, bearish on breakevens
Strategists at HSBC are bullish on TIPS and bearish on breakeven spreads for 2023. As with nominal Treasury yields, the bank believes that “there is likely to be high volatility through 2023 for both real yields and breakeven spreads.” That said, it believes that “investors may see more attractive levels as the year unfolds than are in the market today,” the bank has “a near-term tactical, range-trading view due to the high volatility.” HSBC expounds on its view below:
- ”… Real yields should fall to around 0.50-1.0% at the end of 2023 based on 2.50%, the year-end forecast for 10-year nominal yields….The year-end forecasts put a high probability weight on a hard landing scenario. Thus, 10-year breakeven spreads should fall below 200bp, from their current 240bp area, on the hard landing risks.
“…Ten-year real yields peaked at 1.75% in October and have fallen to 1.1% as we write. The peak levels for real yield should be linked to the longer-run potential GDP trend, in our view, which the FOMC’s economic projection put at 1.8%. A real yield ‘locks in’ a real return. So, if a risk-free Treasury offers the same real return as the economy’s GDP, we think it offers good value. That’s because the economy’s performance varies, and so is riskier than a fixed rate.
“…A steeper real yield curve is our highest conviction TIPS view for 2023. This reflects the risk versus reward for the position based on the one-year forward curve spread versus the spread’s historical behavior.”