USDi: BEs tap themselves out of central bank Dove-Fest

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BEs tap themselves out of central bank Dove-Fest

While nominals seemed to be getting ahead of themselves at various points today in the wake of the Fed’s quasi-dovish hike yesterday, the BOE dovish piggy-back hike today and the ECB’s not-so-dovish hike today, the U.S. inflation asset class decided that ‘enough is enough’ for the time being and ended with a roughly 2-4bps pull back in TIPS breakevens and inflation swaps in the 2y-30y sector this session.

To be sure, nominals flew out of the gates this morning in a modest extension of yesterday’s post-FOMC rally before some pull back into the close while Gilts and EGBs rallied hard (…up to 40bps in some EGBs) in the wake of central bank dovish hikes today. However, while breakevens liked what they heard by Fed Chair Powell yesterday – lifting off intraday lows to end in the black by the close – they never really saw the light of day today with the market mostly offered the entire session.

“The good mood in the TIPS market that appeared late yesterday as Powell's tone swerved dovish was short-lived as breakevens fell across the curve,” one dealer explained.  “The selling we've seen has been more sporadic than the price action would suggest but retail outflows have started to skid lower again and the month-end price action indicated a larger asset-allocation flows that cannot help an already-shifting mindset surrounding the product,” he continued.

Flow-wise, in derivatives-space, inflation swap saw an uptick in activity today with a decent amount of trades hitting the SDR.  Some of the bigger ticket trades on the SDR today included $100m 1y ZC swaps at 225bps, $110m 2y ZC swaps at 231bps, $200m 5y ZC swaps at 240bps, and $110m 10y ZC swaps at 245.5bp (for all of today’s 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 231bps (-3.625bps), 5y at 231.625bps (-3.25bps), 10y at 223.875bps (-2.375bps) and 30y at 220.25bps (-3bps).

JP Morgan: Supportive backdrop for breakevens developing

Strategists at JP Morgan think that “the front end of the inflation curve is currently priced for perfection, implying that inflation falls to the Fed’s 2% target and stays there, even as the slow moderation in growth momentum and resilience in labor markets suggest to us we could see some persistence in inflation into next year.”   The bank expounds on its data-driven view below:

”…Importantly, we think markets could be taking too much signal from the recent softness in rent data. The Zillow Observed Rent Index, for example, which measures asking rents on new leases, peaked above 17% oya in February before softening to under 8% as of December, with the index declining sequentially in each of the last three months. As is well appreciated by markets at this point, fluctuations in prices of new leases tend to pass through to official inflation measures with about a 12-month lag and about a 60% beta, and our model implies that we should still see OER CPI inflation running above 7% through the end of this year.

 

“…But how are the timelier measures of rent inflation likely to evolve from here? We think the extent of the recent weakness is unlikely to persist, as the fourth quarter is a seasonally weak period for new leases. Overall, even as housing demand has softened, supply constraints remain an issue, contributing to our forecast for modestly negative HPA: we forecast a 10% peak to trough decline in house prices, with -5% HPA in 2023.

 

“…Moreover, across the vast majority of metros, renting remains more affordable than housing, reflecting a stunning decline in purchase affordability since the end of 2021. Importantly, even alongside declining home prices and moderating mortgage rates, we think the buy-versus-rent decision is only relevant for the top income tier of renter households, while we estimate captive renters represent roughly 80% of the market. Meanwhile, rental vacancy rates remain near four-decade lows. Therefore, we think landlords will continue to raise rents, with the pace of rent growth going forward likely to be constrained by the pace of wage inflation.”

Meanwhile, JP Morgan expects “the January employment report…to show a 175k gain in nonfarm payrolls, consistent with continued, steady softening in the pace of job growth, as well as a 0.3% m/m increase in AHE. If we are right and the pace of job growth continues to slow, we think the Fed can pause after the March FOMC meeting, which should provide a supportive backdrop for TIPS.”