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Powell and good old fashion rally fatigue pressure BEs lower
Hawk talk from Fed Chair Powell at his semi-annual stint before the Senate Banking Committee managed to weigh on an already fragile inflation market this session. To be sure, Powell – or more precisely the initial headlines from his prepared speech – managed to upset the apple cart after headlines stating that “the ultimate level of interest rates is likely to be higher than previously anticipated” hit the tape this morning.
Reflecting on Powell’s comments, strategists at NatWest felt that they “at the margin leaned a tad more hawkish than other recent Fed officials,” noting that “Chair Powell was noncommittal about the ultimate size of the March rate hike, but clearly put the option of a 50bps hike for March 21-22 on the table: ‘If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.’”
However, the U.S. inflation asset class was already trading off heading into Powell in a continuation of a correction that already started yesterday, sources report. And today’s Powell comments, a soured risk tone (Dow -1.72%, S&P -1.53%, Nasdaq -1.25%), and weaker energy prices (gasoline -3.79%, Brent -3.54%, WTI -3.84%) all help fuel continued weakness this session.
Reflecting on the recent heavy price action, one trader quipped that “the recent sharp (breakeven and inflation swaps) rally is showing a few signs of running out of steam.” Indeed, isolating the 5y sector which was the truest ugly duckling today, the 5y breakeven hit a trough of roughly 213bps in mid-January and hit a recent peak of almost 280bps last Friday. However, the sector has hit a sharp correction over the past two sessions that saw it shed almost 14bps just today.
Flow-wise, in derivatives-space, inflation swap on the SDR today included 1y ZC swaps at 323.25bps, 320bps and 319.5bps, 2y ZC swaps at 290.5bps and 290.25bps, 5y ZC swaps at 279bps, 277.5bps, 277bps, 267.25bps and 267.125bps, 10y ZC swaps at 266bps and 260.875bps, and 20y ZC swaps at 251.75bps and 248.625bps (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 in the screens is at 328.25bps (-10.25bps), 5y at 262bps (-13.375bps), 10y at 239.125bps (-9.375bps) and 30y at 231.75bps (-5bps).
Deutsche Bank: Repricing in front-end BEs; Scope for higher 1y1y swaps
The past month has seen a sharp repricing in front-end TIPS breakevens following upside inflation surprises and revisions to 2022 inflation data. Notably, before the recent correction, 2y TIPS and swaps BEs rose roughly 95bps and 60bps, respectively, and the corresponding 2s5s BE curves have narrowed around 60bps and 25bps.
Looking at how the recent moves in swaps BEs have broken out across the intermediate forward curve, strategists at Deutsche Bank find that a few things jump out:
- ”…First and foremost, the repricing over the past month has been overwhelmingly in 1y BEs.
“…Second, the forward curve 1y and beyond has been remarkably compressed since late last year, with the 1y1y and 2y3y measures generally within around 5bp of each other.
“…. Third, this compression is unusual relative to what we’ve otherwise seen over the current inflationary episode; in general, the forward curve has been downward sloping.”
And in Deutsche Ban k’s view, “this suggests scope for 1y1y in particular to rise if 1y BEs stay around current levels or move up further. For perspective, 1y swaps BE was last above its current level of 3.2% in November. At that time, 1y1y was about 15bp above where it is now.”