USDi: All the stars aligned for BEs; Month-end buying FOMO
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All the stars aligned for BEs; Month-end buying FOMO
The stars remained aligned for the U.S. inflation asset class this session, extending an uber-bullish streak that began with last week’s stellar 10y TIPS auction. To be sure, today’s tailwinds included an utter cornucopia of better-than-expected data (i.e. GDP, jobless claims, durables, new home sale), a pull-back in nominals (~2-5bps), a buoyant risk tone (Dow +0.61%, S&P +1.10%, Nasdaq +1.76%), and a rally in the energy complex (gasoline +0.83%, Brent +1.67%, WTI +1.20%).
Moreover, sources confirmed today that the market has also started to begin to look to month-end trading, where the duration of the Barclays 1-30y Series-L index is expected to extend by 0.26yrs. “The larger upcoming month-end extension combined with the strong auction and price action since has clearly galvanized some fear-of-missing-out activity,” one dealer explained today. “And this only feeds on itself in TIPS as liquidity disappears for bps at a time,” he continued.
Flow-wise, in derivatives-space, inflation swap trades on the SDR today included 3y ZC swaps at 237.5bps, 5y ZC swaps at 244bps, 243.625bps, and 244.125bps, 6y ZC swaps at 246.75bps, 10y ZC swaps at 250.75bps, 251.5bps, 260.625bps, and 251.5bps, and 30y ZC swaps at 248bps and 246.875bps (for more trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Heading into the final hour of trade, the 2y breakeven is going out at 241.25bps (+5.25bps), 5y at 238.875bps (+5.25bps), 10y at 233.875bps (+4bps) and 30y at 233.5bps (+1.75bps).
Barclays: Lower inflation, but not uncertainty, ahead
Market pricing implies expectations of slowing CPI inflation in the coming months, but strategists at Barclays note that there is “significant uncertainty around the path”. Barclays expounds on its view below:
- ”… At our 27th Annual Global Inflation Conference, a central theme was that even as inflation is likely to continue to decline this year from 40y highs, there are plenty of uncertainties and disagreements as to where and when it bottoms, and where it is heading more structurally. By June, the market is pricing in headline CPI inflation to fall to just 2.15% y/y. Some top-down forecasters might be surprised by this – after all, the labor market remains tight – but much of the decline from December’s 6.5% y/y rate is due to energy base effects; retail gasoline prices have fallen 30% since last June and front-month natural gas futures are down more than 60% from last June’s highs. The headline reading is also being dragged down by slowing food and core goods inflation. The decline in food at home CPI has been long foreshadowed by the hard early summer drop in agricultural-related futures (we think the SPGCAL Index on Bloomberg summarizes this best), but even the more wage sensitive food away from home CPI category has also softened lately. Core goods inflation has primarily been a story about used car prices, which early last year had risen over 40% y/y and have more recently been declining. The path ahead for used, and now new, cars is uncertain, but neither are likely to add much positive inflation in the year ahead, in our opinion.
“…Inflation beyond the very near-term is priced for a benign outlook as well, with most forward 1y breakevens out to the 10y point consistent with the Fed undershooting its inflation target. Talking to a broad set of investors at the conference and beyond, most see these as low relative to their outlook. However, we continue to see risks to outright longs. One is that, even in the face of sustained low headline inflation, the Fed remains hawkish because of a stilltight labor market, pushing inflation lower still. Another is that instead of a mild recession, a deeper one occurs, but the Fed is slow to react because it continues to fight the last (high inflation) battle. And, finally, the TIPS market has tended to ‘break’ and become dislocated from fundamentals under the weight of consistent selling pressure, with lower market liquidity and cross-over investors feeling less of a need for inflation hedges. Therefore, instead of outright longs, we continue to like pairing forward long breakeven trades with forward long real yield trades, because we believe if realized inflation follows the path priced by the market, the Fed is not likely to remain as restrictive as implied by forward real yields.”