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BEs on the mends ahead of Oct27 re-opening
The U.S. inflation asset class is on the mends for the third day running as it continues to pull out of last week’s ugly post-FOMC nose-dive. Indeed, as nominals pared their post-BOJ sell-overnight, it’s real yields that are leading today's rebound with TIPS breakevens another ~2-6bps higher as the inflation curve bull flattens against the backdrop of higher energy prices (gasoline +1.97%, Brent +2.34%, WTI +2.41%) and rallying equities (Dow +1.56%, 1.50%, Nasdaq +1.57%).
Flows remain thin for another pre-holiday trade but activity in inflation swaps on the SDR today have thus far included 1y ZC swaps at 244bps and 245bps, 2y ZC swaps at 248.25bps, 4y ZC swaps at 252.75bps, 5y ZC swaps at 253.5bps, 254.75bps and 254.125bps, 10y ZC swap at 243.75bps and 244.75bps, and 30y ZC swaps at 242.625bps, 242,875bps and 244.75bps.
Looking ahead, the market set out to clear the final hurdle of the year for inflationistas with tomorrow’s 5y TIPS re-opening (see a preview below). But with the 5y TIPS real yield rallying roughly 7bps since Monday’s close, one dealer jokingly quipped “we could wonder if someone forgot the $19bn supply... tomorrow with the Oct27 reopening.”
In the late morning trade, the 2y breakeven is trading in the screens at 225bps (+6.125bps), 5y at 235.625bps (+3.5bps), 10y at 227.75bps (+3bps) and 30y at 231.25bps (+1.75bps).
Barclays: 5y TIPS auction preview – Don’t forget year-end TIPS
Tomorrow’s $19bn 5y TIPS reopening (Oct27s) comes at “a precarious moment for the market,” in the view of strategists at Barclays. Even though 5y TIPS auctions have frequently stopped-through WI trading levels, the bank sees reasons to be hesitant because inflation has likely peaked and the Fed remains hawkish. Barclays presents its auction preview below:
- ”… 5y TIPS reopening could represent a buying opportunity for investors, with real yields above 1%, even as the Fed signals further tightening because concerns of a recession in 2023 may rise. That said, there is a variety of reasons to think that the auction could receive tepid demand, including strained trading conditions, heavy primary dealer balance sheets (at least when it comes to TIPS), and a structural return of positive real term premium. Overall, we see risks as skewed toward the first tail at a 5y TIPS auction since December 2021, especially because of a hawkish Fed.
“…The largest tailwind to the auction, in our opinion, is the fact that real yields are now well into positive territory, even if they have richened somewhat in recent months. At this point, the market has priced the path of forward one-year real yields at or solidly above most estimates of neutral real rates across the entire term structure, though our sense is that this is not a pure expectations signal, as real term premium has returned in force. Whether real yields will be sustained above neutral levels, even as the Fed slows the rate hiking cycle, remains an outstanding question, though our sense is that upward pressure on real yields were persist for some time, due partially to non-fundamental factors.
“…Headwinds to the auction are numerous. Real yields are notably richer since peaking earlier this year, even as TIPS funds - especially in the front end - have had sizable outflows of late, and primary dealer balance sheets have the largest net long position on record…Although 5y TIPS have historically stopped-through WI trading levels, the initial offering of the current 5y on-the-run had tepid demand, as indicated by the lowest bid-to-cover ratio since 2016, as well as the fact that the issue cheapened c.6bp post-auction into the close that day.”