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BEs keep a good thing going despite obstacles
The U.S. inflation market managed to keep a good thing going despite the headwinds of a nominal rally (~2-6bps), a soured risk tone (Dow -0.61%, S&P -1.11%, Nasdaq -1.68%) and an utter torrent of hawk-talk from numerous Fed officials today (i.e. Williams, Cook, Barr, Bostic, Kashkari, Waller Brainard).
To be sure, despite these challenges, TIPS breakevens and inflation swaps continued to bull-flatten for the third consecutive session as end-user demand has continued to propel the market higher – with an added assist once again from higher energy prices this session (gasoline +0.42%, Brent +1.66%, WTI +1.69%).
“The front-end was again the best performer on the curve and that is where we have seen the most consistent interest this week,” one dealer relayed. “Further out has been more mixed here but clearly there are larger buying forces at work given the real yield move on a day like today,” he continued.
Meanwhile, in derivatives-space, inflation swap saw some decent activity today with some of the bigger ticket trades on the SDR today including $50 1y ZC swaps at 252.5bps, $56m at 254.5bps, $50m at 258bps and $50m at 253bps, $50m 2y ZC swaps at 252.5bps, $140m 3y ZC swaps at 256bps, $62m 4y ZC swaps at 254.5bps, $140m 5y ZC swaps at 258bps, $50m at 256.5bps and $50m at 257bps, $140m 10y ZC swaps at 255.625bps, and $50m 30y ZC swaps at 243.875bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Looking ahead, tomorrow, the Treasury will formally announce this month’s new issue 30y TIPS auction, which will almost certainly be for $9bn.
Heading ino the final hour of trade, the 2y breakeven is going out at 263.5bps (+7.5bps), 5y at 250.05bps (+4.75bps), 10y at 236.25bps (+4.125bps) and 30y at 231bps (+4.125bps).
Barclays: Taking issue with Wacky TBAC-y on TIPS
Strategists at Barclays disagree that a Treasury buyback program of 0-1y TIPS, funded by bill issuance, as discussed in the latest TBAC charge, would support the broader TIPS market, and instead think that an on-the-run for off-the-run TIPS switching program at auctions could lead to improved TIPS market liquidity.
Indeed, within a response to a charge to discuss a Treasury buyback program that could provide liquidity support as well as improve cash management, TBAC recently suggested that the Treasury could “enhance liquidity to the broader TIPS sector, potentially creating additional demand for longer maturity TIPS,” through buybacks of 0-1y TIPS funded by issuing more bills.” But Barclays disagrees with this conclusion, but even more with the basis of it, and instead thinks that an on-the-run for off-the-run TIPS switching program at auctions like one outline below could lead to improved TIPS market liquidity:
- ”… Rather than run the risk of distorting a market for which there is a growing real money demand base, we think it makes sense for the Treasury to run a switch program where it stands ready to accept off-the-run TIPS in exchange for auction add-ons if the Treasury finds the spread attractive. The idea here is similar to the Fed’s purchase operation, where the operation itself was regular and predictable, but the amount and exact CUSIPs bought were in part dependent on offers submitted. If the market functioned fine on its own, there would likely be few cheap offers (cheap from the Treasury’s standpoint), and no switches would occur. However, if markets were stressed and balance sheets full, off-the-run spreads to on-the-runs might widen enough that the Treasury’s switch facility could help improve market functionality, without the Fed needing to step in with emergency measures.
“…In our view, the sector that might benefit the most from this is the 7-8y TIPS sector, where forward 1y breakevens tend to trade cheap to forwards closer to the on-the-runs. This sector is often a canary in the coal mine for market functioning issues, and we tend to see wider swings in spreads to our fitted spline curve, with moments in the past year even nearing the dislocations seen in March 2020 by some metrics. A number of approaches could work, but a standing facility could be set to allow <5y issues to be exchanged on spread at 5y auctions, >5y to <10y issues exchanged at 10y auctions and >10y to <30y at 30y auctions. There should be no concern about whether investors can absorb additional on-the-run issuance, because auction sizes would only increase if investors desired to switch. The Treasury could line up settlement dates so there would be little impact on cash-management. Obviously, the Treasury would have to develop an internal threshold for how cheap a spread needs to be to be accepted, or whether exclusions need to apply when a CUSIP’s outstanding float gets too low (either through previous buybacks or Fed purchases), but these are details that can be ironed out in discussions. We encourage the Treasury to explore such a facility.”
- Credit Suisse is working on a self-led CPI-linked note maturing Dec 2024 that pays a coupon tied to CPI NSA +5% spread, floored at 3%. EMTN.