USDi: BEs bull flatten along with EURi into month-end

Chart numbers candles 14 Jun 2022
BEs bull-flattened along with EURi amid a rise in energy prices and a healthy month-end bid.

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  • BEs bull flatten along with EURi into month-end

  • JP Morgan: Turning neutral on inflation

  • Inflation-linked structured notes


    Click here for SDR inflation swap trade


    BEs bull flatten along with EURi into month-end

    The inflation bogeyman reared its ugly head once again today – this time across the pond where French euro HICPx printed at 7.2%yoy versus the 7.0% Bloomberg consensus while Spanish euro HICPx came in at 6.1%yoy versus 5.7%. “Indeed, the inflation numbers were higher than expected, the 1y fixing outperformed and the curve flattened again,” said one euro inflation trader earlier today (see EURi).


    And stateside, USD traders generally judged that boost in the euro inflation market also spilled a bit into today’s bull-flattening in the TIPS and inflation swaps curves.  But beyond that, inflationistas also highlighted today’s bounce in energy prices (gasoline +2.79%, Brent +1.45%, WTI +1.60%) as well as month-end index activity where the additions of the newly-minted Feb53 TIPS adding “a bit more action” as well  as “a larger-than-average extension” this session. 


    Thus, with month-end activity still brewing in the backdrop into the final hour of trade, dealers are seeing the inflation curve roughly 3-13bps higher in the screens amid a modestly sullied risk-backdrop (Dow -0.71%, S&P -0.30%, Nasdaq -0.1%) and recovery in nominals that sees yields up to 1.5bps lower.


    Flow-wise, in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 216bps, 317.5bps,  318.5bps and 319.5bps, 2y ZC swaps at 283bps, 285bps and 287bps, 3y ZC swaps at 273bps, 274.5bps and 274.75bps, 4y ZC swaps at 268bps and 269.25bps, 5y ZC swaps at 264.5bps and 267bps, and 10y ZC swaps at 259bps and 262.25bps (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 319.5bps (+10.75bps), 5y at 261bps (+4.75bps), 10y at 239.25bps (+2bps and 30y at 234.375bps (+2.125bps).



    JP Morgan: Turning neutral on inflation

    Given the significant bullish repricing that has occurred in the inflation market, strategists at JP Morgan took profits on their 1Yx1Y inflation swap longs and turned neutral on inflation last week, for the following number of reasons:


      ”…First, breakevens are no longer pricing a relative discount versus other markets…The residual of our 5-year breakeven had opened up to more than 30bp last month, but this residual has now closed, as breakevens have widened even alongside declines in broad commodity prices and widening in credit spreads over recent weeks. With breakevens more fairly valued versus fundamental drivers, this removes one impetus for further widening over the near term.


      “…Second, while the string of data prints in recent weeks has challenged the disinflation narrative and temporarily provided a supportive backdrop for breakevens, the need for more hawkish monetary policy could make a soft landing harder to achieve as we look toward the end of this year and beyond. The abrupt repricing in Fed expectations in recent weeks—with 2-year Treasury yields 60bp higher MTD—has driven interest rate volatility higher, tightened financial conditions, and driven risk assets lower. While our baseline forecast still calls for a terminal Fed funds target rate range of 5.0-5.25%, we recognize the Fed may have to hike further to drive more significant cooling in labor markets and get inflation on a sustained path to 2%.

      “…Third, we previously argued that commodities, and oil prices in particular, could be supported over the near term by the China reopening, OPEC+ production cuts, and a move by the US administration to replenish SPR reserves. However, with China reopening occurring earlier than we had projected in our annual outlook, there is no longer a need for OPEC+ to reduce production quotas this year, and we also now assume higher prices will prevent US administration from repurchasing oil for SPR this year and next. Thus, it’s more difficult to identify a near-term catalyst to drive oil prices higher. Moreover, hopes for a strong China reopening have given way to concerns about falling cargo shipments, building commodity inventories, and lackluster sales of homes and cars.


      “…Fourth, despite the reversal in the disinflation narrative over the past month, and breakevens repricing wider, retail demand has remained poor….The top 10 TIPS-focused ETFs have continued to record outflows in recent weeks, with the 4-week moving average at -$637mn. As we’ve noted in the past, retail flows tend to be momentum-driven to an extent, and the rise in real yields has likely  kept these investors on the sidelines. Thus, we’ll likely need to see greater stability in yields and positive realized returns before demand from this investor base turns more supportive.”


    Thus, given the material repricing observed over the past month, fair valuations, elevated medium-term recession risks, and limited near-term catalysts that could drive breakevens materially wider from these levels, JP Morgan remains neutral on breakevens.



    Inflation-linked structured notes


    • Credit Suisse is working on a self-led $1.35m CPI-linked note maturing Feb 2025 that pays CPI +2.8%, floored at 2.8%. Eurodollar. 


    • Credit Suisse is working on a self-led $2m CPI-linked note maturing Dec 2024 that pays CPI +5%, floored at 3%. EMTN.