USD Swaps: PPI pops pivot bubble again but UofM mollifies; Favored 2023 trades

Puncturing bubble 21 Jun 2021
A stronger-than-expected PPI print today was mollified but UoM data but unlike equities, USTs remain pressured. BofA’s favored rate trades for 2023.

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  • PPI pops pivot bubble again but UofM mollifies

  •  BofA; Favored rate trades for 2023 


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    PPI pops pivot bubble again but UofM mollifies

    A hotter-than-expected November PPI report popped the pivot bubble once again but the subsequent University of Michigan data showing inflation expectations coming down quickly eased the blow ahead of next week’s much-anticipated FOMC decision. 


    To be sure, wholesale prices came in at +0.3% MoM/+7.4% YoY (versus Bloomberg consensus of +0.2% MoM/+7.2% YoY).  However, this upside surprise in today’s inflation data was countered by UofM 1y inflation expectations falling down to 4.6% (versus Bloomberg consensus of an unchanged 4.9%).  In all, one source judged that today’s data “won’t shift the balance much at the Fed” as he still expected a 50bps rate hike next week along a terminal rate of around 5% to 5.25% down the line.


    On the heels of this heavily-weighted but mixed batch of inflation data, the major domestic equity indices opened up in the red but have since clawed back those losses to currently trade narrowly mixed in the screens (Dow -0.11%, S&P +0.16%, Nasdaq +0.33%). 


    However, Treasuries took a big bear-steepening hit and have yet to show any meaningful rebound thus far in the early afternoon trade.  Indeed, the benchmark 10y note yield is last 7.4bps higher at 3.55^ while the 5s30s spread is 6.6bps wider at -21.3bps ahead of next week’s duration heavy supply of $40bn 3y notes, $32bn 10y notes and $18bn 30y bonds.


    Meanwhile, in the Eurodollar trading pits, reds and greens are posting 0.5 to 6 ticks softer as the strip also bear steepens post-data.  And in swaps, spreads mixed with the spread curve also steepening along with underly rates ahead of a completely blank slate of IG issuance this session after just roughly $4.25bn priced this week.


    Currently, 2s 4bps (-0.5bps), 3s -17bps (-0.5bps), 5s -24bps (+0.5bps), 7s -33.375bps (+0.875bps), 10s -29.875bps (+0.875bps), 20s -62.625bps (+0.25bps), 30s -63.75bps (+0.75bps).



    BofA; Favored rate trades for 2023

    Looking ahead, while all eyes are on the last two big hurdles of the year next week (i.e. November CPI, December FOMC meeting), strategists at BofA have looked even deeper into their crystal ball to prognosticate about 2023.  And looking at the big picture, the bank expects “macro uncertainty to decline in '23” due to “slower pace of Fed hikes / eventual pause, falling though still high inflation, softening labor market, USTs regaining their risk-off hedge value with increased demand.”  Based on this broader view, BofA highlights its favorite rate expressions across some of its major coverage areas below:


      ”… Duration: we expect rates to realize well below forwards by end '23. Near term, we recommend clients remain underweight front end and neutral back end. We like fading the degree of cuts priced in 2H23 and think that terminal has room to re-price higher. More data is needed to justify Fed pause (another soft CPI, NFP miss, etc). Medium term, we are constructive duration with economic slowdown and end to hikes….When to get long? Buy duration after last Fed hike. Leaning long is historically attractive 2-3m before the last Fed hike. Our forecast for a final hike in March implies more conviction in a long duration bias early next year, assuming jobs slow as we expect.


      “…Curve: the curve should steepen in '23, most likely bull steepen as the Fed cuts to offset a weakening labor market. However, the curve could modestly bear steepen as well if the Fed prematurely turns dovish or if there is a UST liquidity event. We suggest waiting for more clarity the last Fed hike is near before entering outright steepeners.


      “…Vol: vol will fall. The left side of the grid to underperform vs the right side to flat levels by end-1Q23 and trade cheap to the right side by year end (around 100bp or lower for 1y1y). Vol trades: receiver ladders in frontend/belly, US vs EUR receivers, short left vs right side vol, 2s10s caps/cap spreads & right side fwd vol (long vega vs intermediates).


      “…Real rates: we are constructive 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.


      “…Front end: rates should be moving higher with bills & CP cheaper. On bills, eventual debt limit resolution is expected to unleash a tidal wave of bill supply: 1y SOFR/FF to remain stable or wider before resolution but tighten meaningfully after. On MMF reform, we expect prime outflows, increased bill demand & CP cheapening; 3m L-OIS could increase 3-7bp.


      “…Spreads: we expect a steeper spread curve. Front end spreads should tighten with bill supply late in '23 while long end spreads should benefit from lower coupon supply and improving UST demand. Market structure changes may also help the performance of long end USTs, especially if Treasury proceeds with a buyback plan. If Fed QT ends in '23 would be very supportive of long-dated spreads. US dollar stabilization also likely to benefit belly spreads, and potentially bank demand if loan growth slows.


      “…Bottom line: rates likely headed lower in '23 (esp real), curve steeper, vol drop, spread curve steeper (front end tighter, back end wider).”