USD Swaps: EU inflation data softens USTs; Fade front-end spread widening?

Chart line down Oct 2022
USTs have softened a tad in sympathy with EGBs after stronger inflation data out of the EU. NatWest argues against fading front-end spread widening.

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  • EU inflation data softens USTs; Fade front-end spread widening?

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    EU inflation data softens USTs; Fade front-end spread widening?

    Higher than expected inflation prints today in both France and Spain (see Total Derivatives) have added more fuel to the ‘pivot trade’ of pricing in higher peak interest rates in the near future and pricing out rate cuts later in the year in favor of multiple more hikes. Accordingly, EGBs are currently seeing 4-8bps rises in rates in the screens.


    Stateside, despite a small flurry of weaker-than-expected data (i.e. MNI Chicago PMI, consumer confidence, Richmond Fed), Treasury yields are inching higher largely in sympathy with todays’ price action across the pond.  The benchmark 10y note yield is up 2.3bps at 3.938% while the 5s30s spread is 0.3bps wider at -23bps.  Shorter in, red and green SOFR futures are up to 0.5 ticks firmer to 3 ticks softer. 


    Meanwhile, swap spreads are mostly lightly bid amid below-average activity, if best seen at the 10y and 30y points.  In the backdrop, IG issuance continues to hit the tape at a healthy clip amid today’s rudderless risk tone (Dow -0.48%, S&P +0.05%, Nasdaq +0.01%) after a sizeable $19bn in new deals priced yesterday.  Today sees swap candidate deals from Citigroup and HSBC coming out of the FIG corner.    


    Elsewhere, despite a deluge of T-bill issuance, short-dated swap spreads in the front sharply repriced higher.  And while funding typically plays a large component in the front-end of the spread curve, strategists at NatWest point out that “it isn’t the only driver.”  Indeed, for the recent widening in front-end spreads, the bank believes that it was “more so directionally driven and less so due to relative-funding changes (albeit that factors in as well).”  NatWest expounds on this view below:


      ”… Over the past year, we had two major spikes in OIS forwards – the first one was in June 2022 and the second one in September 2022. Those episodes were accompanied with sharply widening 2y spreads as well. We think that is due to two main reasons: a) the 2y note often trades special when forwards jump like that, likely due to traders who need to locate their shorts and b) as investors flock to protect themselves against the newly ‘discovered’ upside risks for the Fed path through interest rate options, intermediaries likely use the swap component to hedge themselves.


      “…That dynamic becomes more evident as we observe the directionality of front-end spreads to the underlying rates – the correlation isn’t as significant during times of low volatility but picks up when a major repricing in the Fed path occurs. Looking forward, we don’t think now is the right moment to fade the widening as the punitive carry makes ill-timed trades punishing. We avoid front end tighteners for two main reasons: 1) We will have a set of inflation and jobs data during Fed’s blackout period, which leaves the position susceptible to another directional move 2) Debt ceiling related issuance is about to turn around and become negative, leading to more collateral scarcity and richening of short-dated paper vs. funding.”


    Currently, 2s 11bps (-0.375bps), 3s -5bps (+0.25bps), 5s -18.625bps (+0.25bps), 7s -29.25bps (+0.125bps), 10s -26.875bps (+0.125bps), 20s -60.375bps (+0.625bps), 30s -67.875bps (unch).



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