USD Swaps: Traders await last sting in the tail

Balloon 9 jul 2020
After bull-flattening on fears of a slowing economy after GDP data yesterday, the UST market is now bracing itself for a possible change of mood.

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  • Traders await last sting in the tail

  • Barclays: Sticky inflation supports 2s5s SOFR flatteners

  • New issues


    Traders await last sting in the tail

    After bull flattening on fears of a slowing economy after GDP data yesterday, the Treasury market appears to be preparing for a reversal of those concerns ahead of the very vogue PCE data that is coming up in about half an hour.


    With Fed hawks getting noisier in their concerns about the need not to let inflation of the hook as it looks to head higher again, PCE, the Fed’s favourite inflation indicator, has grown in significance ahead of today’s release which is forecast to see January PCE rise 0.5% mom and 5.0% yoy.


    Even an on-target outcome would, according to Barclays strategists below, raise the risk of an extended rate hike peak, while an overshoot would significantly undermine what is left of the optimism that emerged in January regarding a swift end to this high inflation phase.


    These concerns see USTs slightly underperforming other major bonds markets today, led by the 10y sector where UST yields are +3.5bps at 3.91% versus moves of 1-2bps in equivalent Bunds and gilts.


    On the UST curve 2s/10s is flat while 10s/30s is 1.5bps flatter, which makes sense for a market trading on hawkish concerns.  In swap spreads the curve is also ever-so-slightly flatter with the 2y ASW +0.5bps at 8.5bps, while 5y is flat at -19.5bps, 10y is marginally more negative at  -28bps and 30y is also fractionally lower at -68bps.


    But that has little to say about where the market will end today. After yesterday’s soggy 7y auction and the roughly 10bps sell-off in 10y UST yields this week, there is space for a good bounce on a soft PCE outcome. A high number though could see 10y yields heading towards 4% for the first time since November.



    Barclays: Sticky inflation supports 2s5s SOFR flatteners

    Strategists at Barclays say in their latest USD fixed income research that the risk of a higher rate peak in the US thanks to sticky inflation may prove fleeting, but for now supports front end curve flatteners. In particular, Barclays says it “We recommend 2s5s curve SOFR flatteners (entry -87bp). As noted above, the front end is still vulnerable to the risk of a stickier inflation leading to a more restrictive policy stance. However, intermediate rates should price in a return to normal policy rates with additional risk of a more aggressive easing cycle in a delayed hard landing scenario.”


    It notes that “the inflation backdrop appears to have worsened and it is not limited to a few sectors. While the Fed’s core PCE inflation forecast of 3.5% this year is above consensus, an expected 0.5% core PCE print in January is likely to lead the Fed to revise their forecast higher. Further, should core PCE inflation print at 0.5% in February as well, inflation would need to fall sharply over subsequent months to keep the Fed’s inflation forecast from getting revised reasonably higher.”


    However, it says “the Fed is unlikely to make that assumption of rapidly falling inflation later in the year, if labor market data also remain strong. In that context, there is a risk of the Fed hiking more aggressively, raising the real rate further into positive territory of say, close to 2% (example 5.75% fed funds - 3.75% core PCE inflation), at which point policy would be quite restrictive (by 1.5pp = 2% real rate minus 0.5% real neutral rate) . Such tight policy would increase the risk of a recession down the road in our view, which might eventually be seen as necessary to get inflation back to 2% . This scenario is becoming more likely given the recent strength in the data.”


    In conclusion, Barclays repeats that “we see room for the front to intermediate curve to invert even more and recommend 2s5s curve flatteners (-87bp).”


    New issues:  

    • Eli Lily yesterday priced a 4-part $750M 3NC1, $1bn 10y, $1.25bn 30y and $1bn 40y benchmark via CS, GS, JPM, and MS.  A2/A+.  Priced at +65bps, +85bps, +100bps, +115bps.


    • Raytheon Technologies yesterday priced a $500m 3y, $1.25bn 10y and $1.25bn 30y benchmark via Citi, DB, GS and MS.  Baa1/A-.  Priced at +60bps, +130bps, +150bps.