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New Jan33 TIPS turn a blind eye to RY rally
Neither yesterday’s massive real yield rally nor today’s more modest rally were able to derail the introduction of $17bn new 10y TIPS to hungry inflationistas today.
To be sure, the new Jan33 TIPS auction stopped roughly 4bps through the 1pm market to draw a yield of 1.22% and a rather solid 2.79x bid-to-cover (notably, the highest bid-to-cover ratio since 2019). Indirect bidding jump to the second-highest share of 79.3% while directs bidders took down 13.1%, leaving dealers with a record low of 7.6%. And these impressive results came in the face a soured risk tone (Dow -0.76%, S&P -0.76%, Nasdaq -0.96%) and plenty of hawkish Fed-speak (i.e. Collins, Brainard) this session.
In the trading screens, breakevens cruised into the auction better bid across the board as nominals consolidated off of yesterday’s gains. And once the auction results hit the tape, breakevens gapped even higher and never looked backed. And with the dust settling after the first TIPS auction of 2023, dealers are marking the inflation curve a rather solid 7-11bps higher in the 2y-30y sector against the backdrop of a 2-4bps rise in nominal yields.
“We started the day on the bid side after better than expected jobless claim, but it moderated, and we traded around until noon when flows switched one way and breakevens jumped 3bps into the auction,” one dealer explained. “Post auction, aggressive buyers had the upper hand and breakevens kept their momentum up not without some initial resistance,” he continued.
Flow-wise, in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 203bps, 2y ZC swaps at 219.75bps, 5y ZC swaps at 224.75bps, 224.5bps, 225bps, 226bps and 232.5bps, 10yZC swaps at 241.125bps, 20y ZC swaps at 231bps and 30y ZC swaps at 231.75bps and 232.5bps (for more trades, see Total Derivatives SDR).
Heading into the final hour of trade, the 2y breakeven is going out at 215bps (+10.625bps), 5y at 223.75bps (+10.625bps), 10y at 222.875bps (+10.75bps) and 30y at 224.25bps (+7.875bps).
Citigroup: Short bias for inflation breakevens amid conflicting signals
Strategists at Citigroup have a short bias for inflation breakevens and they’ve expressed it via a short in 1y1y inflation swaps and they’ve hedged their energy exposure by selling OTM crude oil puts. The bank explains that “the idea here is that 2.4% inflation for 2024 seems high in the context of rate cuts priced for 2024 and the expectations of a higher unemployment rate by YE 2023.”
Citigroup finds that “a simple macro model correlating 6m changes with ISM prices shows that the trend in breakevens is lower, unless the drop in ISM prices start reversing. Interestingly, with the drop in breakevens, our cross asset fair value model is now signaling that 10y BEs are cheap by 30bp (rising copper prices driving the FV higher).”
Caught between these two conflicting signals, Citigroup is inclined to wait to add a long 10y10y inflation swap as a hedge against the short 1y1y.