USDi: ISM price paid helps BEs bull-flatten again; Positive carry returns

Chart lines Oct 2022
Strong ISM price paid data helped BEs bull-flatten again. Barclays notes that positive carry returns to TIPS again.

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  • ISM price paid helps BEs bull-flatten again; Positive carry returns

  • BofA: R* inconsistency argues for flatter real yield curve


    Click here for SDR inflation swap trade


    ISM price paid helps BEs bull-flatten again; Positive carry returns

    More heavy whiffs of persistent price pressure continued to support the U.S. inflation asset class this session.  This time the data hit stateside ( opposed to across the pond yesterday - see USDi) with this morning’s ISM prices paid which came in at a much hotter-than-expected 51.3 (versus 46.5 Bloomberg consensus).  Digging into the implications of this pricing data, strategists at Barclays posit the following:


      ”… The input cost index came in at 51.3, 6.8pts higher than its January reading, and a significant change following a series of sub-50 readings from October through January. This reinforces evidence that January's firming in consumer goods prices (in CPI, and especially PCE prices) was not idiosyncratic, but driven by firming cost fundamentals. Although the overall input cost index seemingly emerged from contractionary territory in February, cost developments were mixed across industries, with eight of the eighteen industries reporting increased input costs last month versus four in January. According to the ISM, ‘a prices index of 52.9 percent, over time, is generally consistent with an increase in the for intermediate materials.’ This implies that input costs are leveling, not re-accelerating, which is consistent with what we had inferred from the January data on goods prices; nonetheless, this is more bad news for those who had expected declining goods prices to continue to push broader disinflationary pressures in the coming months.”


    Post-data, nominals got hit hard once again with yields closing out roughly 4-8 while TIPS breakevens got another boost roughly 3-7bps as the inflation curve continued to bull-flatten this session.  In the backdrop, equities serves as a minor headwind for inflation (Dow +0.02%, S&P -0.47%, Nasdaq -0.66%) while the energy complex served as a minor tailwind (gasoline +1.19%, Brent +1.10%, WTI +0.83%).


    Flow-wise, in derivatives-space, inflation swap saw a decent number of trades on the SDR today. Some of the bigger tickets printed this session included $150m 1y ZC swaps at 316.75bps, $500m at 318bps and $100m at 320.75bps, $110m 9y ZC swaps at 263.375bps, and $100m 10y ZC swaps at 262.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).


    “After a month-end day that finished on the offer side, the market recovered aggressively this morning and even more after the ISM figures after few hesitations,” one dealer explained.  “Breakeven traded slowly but firmly up all day with only a small pause at 11am when yields tried a small recovery,” he continued.


    Finally, as we enter the month of March, strategists at Barclays note that “we’ve returned to a period of positive carry for the TIPS market that, based on the accrual implied by the CPI fixings market, may persist through the rest of H1 23. Whether this differential carry profile results in new inflows into the TIPS market remains to be seen; for context, TIPS ETFs had net inflows on only two days in February, and the 20d cumulative outflow is now one of the largest seen in recent years.”


    Heading into the late close, the 2y breakeven is going out at 325.25bps (+7.125bps), 5y at 267bps (+7.5bps), 10y at 243.625bps (+5.75bps and 30y at 236.375bps (+3.25bps).



    BofA: R* inconsistency argues for flatter real yield curve

    On the back of their higher nominal rates forecast revisions last week, strategists at BofA reflect a more deeply inverted real yield curve into the end of this year. Indeed, the bank thinks that “there is currently a dislocation between market pricing of real yields at the back-end of the curve vs the front end, which argues for an even deeper inversion than our modal scenario reflects.”


    While BofA can't say that the market pricing of a 190bps r* is incorrect (10y20y TIPS adjusted for 30bps CPI/ PCE wedge), it believes that “it is inconsistent with implied real yields at the front-end of the curve given the current/ expected economic backdrop.”  Thus, the bank suggests that “this argues for a more deeply inverted real yield curve, with a correction either in the back-end (lower pricing of r*) or front-end (higher pricing of terminal rate).”  BofA recommends clients position for this by initiating a 1y forward, 5s30s real yield curve flattener, which it details more specifically below:


      ”…We recommend investors position for a flatter 5s30s real rate curve, 1 year forward by going short Jan '29 TIPS vs. long Jan '24 and Feb '52 TIPS. We implement this trade in forward space to account for carry associated with a spot 5s30s real rate flattener trade. The trade is market value and duration neutral, with +12%/-100%/+88% risk weights across the '24 /'29 /'52 maturities. Current level is -5bps, target is -40bps, stop out is +15bps. The main risk to the trade is that inflation falls more quickly than expected and drives a more dovish reaction function for the Fed to be priced near term while real yields at the back-end of the curve are more sticky.”