USDi: BEs rally again, but not out of the woods yet

Reindeer snow Dec 2022
BEs rebounded nicely amid continued risk-on sentiment. But sources caution that market is not out of the woods yet ahead of FOMC and 10y TIPS supply.

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  •  BEs rally again, but not out of the woods yet

  • JP Morgan: Hesitant to move off the sidelines on BEs

  • Inflation-linked structures


    Click here for SDR inflation swap trade


     BEs rally again, but not out of the woods yet

    With the dark and nebulous clouds of uncertainty that have hovered over the financial/banking system continuing to timidly part today, the U.S. inflation asset class wasted no time jumping on the risk-on bandwagon for the second consecutive session – leaving late last week’s risk-off-driven dumpster fire a distant memory.


    To be sure, Treasury Secretary Yellen managed to further assuage the markets and buoy risk sentiment today by telling the American Bankers Association that ““similar actions (to SVB) could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.”  However, sentiment was already on the mends even before Yellen’s comments hit the tape as heavily-watched First Republic Bank shares closed up 29% today which help fuel a broader advance today (Dow +0.98%, S&P +1.30%, Nasdaq +1.58%).


    And against the corresponding 6-19bps bear-flattening in nominals, the TIPS breakevens and inflation swaps curves bull-flattened to the tune of roughly 6-12bps with an added assist from higher oil prices this session (Brent +1.92%, WTI +2.50%).  However, despite the recent rebound in the inflation market, some remain reluctant to declare that we’re out of the woods just yet.  “With a newly-debatable FOMC decision and a chunk of 10y supply coming up in the week, the market remains on edge and will trade jumpy in either direction until further notice,” one dealer cautioned.


    In derivatives-space, inflation swap on the SDR today included 1y ZC swaps at 267bps, 270bps, 270.75bps and 272bps, 2y ZC swaps at 245.5bps, 246bps and 247.5bps, 5y ZC swaps at 245.5bps, 246bps and 246.25bps, and 10y ZC swaps at 246.375bps, 247bps, 247.25bps and 246.75bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).


    Looking ahead, the highlights for the TIPS market this week are set to be the March FOMC meeting tomorrow, where economists at Barclays anticipate a 25bp hike, in line with the market’s pricing of a 70% probability, and the $15bn reopening of the TIIJan33s on Thursday; for Barclays preliminary auction preview see USDi


    Heading into the final hour of trade, the 2y breakeven is trading in the screens at 275.875bps (+12.625bps), 5y at 233.375bps (+8.25bps), 10y at 223.875bps (+8bps) and 30y at 221bps (+6bps).



    JP Morgan: Hesitant to move off the sidelines on BEs

    Strategists at JP Morgan continues to project core CPI and PCE inflation above 3% oya at year-end. And given this baseline forecast, the bank believes that “the front end of the inflation curve appears cheap, and we think there is room for breakevens to widen over the medium term.”  However, from a tactical perspective, JP Morgan remains “hesitant to move off the sidelines just yet” and the bank expounds on this view below:


      ”…The outperformance of breakevens versus risk assets and commodities (last) week could be undone if the Fed pushes forward with a 25bp hike (tomorrow) and reinforces its commitment to fighting inflation, especially while fears of financial contagion remain elevated. Additionally, even as market liquidity has dropped to March 2020 levels in nominal Treasury markets, we see little evidence of liquidity preference in the TIPS market… (T)he RMSE of our real yield spline curve remains low. Additionally, for most of the week, we saw limited outperformance of more liquid on-the-run securities:…(T)he option-adjusted nominal z-spread differential between current 5s and double-old 5s… has been fairly stable, in contrast to the experience of March of 2020. If risk aversion remains elevated, and liquidity conditions deteriorate, we would expect to an increase in the liquidity risk premium embedded in breakevens, driving an underperformance of TIPS relative to nominals. Against this backdrop, we will wait for cheaper valuations before positioning for wider breakevens.”



    Inflation-linked structures

    • Credit Suisse is working on a self-led $8m inflation-linked note maturing Mar 2025 that pays CPI +3%, floored at 3%. Eurodollar. Announced Mar 17.