EURi: Weak German auction; New OATi talk; Profits causing inflation?

Arrow up and down Oct 2022
A weak German linker auction, soft US JOLTS data and speculation about a new OATi all buffeted the inflation market today.

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  • Weak German auction and soft US data weigh on inflation; New OATi? 

  • MS: Cheaper euro hedges to benefit from rise in French risk

  • BNPP: Greedy bosses or militant unions – the solution is the same


    Weak German auction and soft US data weigh on inflation; New OATi?

    Euro inflation swaps finished at the bottom of the day’s ranges and were around a couple of bps lower across the curve following a disappointing German linker auction, soft US jobs data and weaker oil prices – the latter even after the surprise OPEC+ supply cut earlier this week. Underperformance by French inflation also stoked speculation about a new OATi printing as soon as this month, with FRF 10y swaps around 4bps lower.


    Traders highlighted the lower level of volatility today versus last week’s big, data-driven swings. However, the German auctions were described as “very weak” with only €442m of bids for the Bundei-33 (versus €450m offered and €352m sold) and €169m of bids for the Bundei-46 (versus €200m offered and €82m sold). “There was a cent of overbidding on the 10y and two cents at the long end,” a dealer noted, meaning that the DFA "had to serve below the mid to do their size.”


    Inflation lost ground after the auction results hit the screens. Later, a post-JOLTs slide in oil prices and TIPS added to the pressure, with 5y TIPS breakevens around 7bps tighter and Brent futures down 40 cents just after the European close.        


    French inflation underperformed euro with the 5y5y spread tightening to around 38.5bps (-2.5). OATi lagged OATei and dealers wondered whether the AFT’s planned syndication of a new 15y to 20y OATi in 2023 would come this month.    


    Finally, inflation swap trades showing on the SDR towards the end of the session included EUR 10s/20s at 10.7bps, 30s/40s at 12.5bps, 10s/15s at 5bps and 20y at 2.58%, 2.575% and 2.5875%.    


    MS: Cheaper euro hedges to benefit from rise in French risk

    Demand for assets to diversify and to hedge inflation risk is likely to rise alongside increased inflation uncertainty, conclude inflation strategists at Morgan Stanley today. And with French inflation hedges still expensive against euro assets, OATei should benefit despite Livret A’s link to FRF CPIx rather than euro HICPx, they suggest. The bank explains:


      “High and volatile inflation for longer is likely to support further flows into Livret A accounts, which are consistently gaining popularity…Under-hedged investors will probably feel incentivised to hedge a growing proportion of their inflation-linked obligations”


      “The Livret A formula rate should keep growing over 2023 with a peak at 4.3% and a long-run level slightly below 3%. Barring a disinflation/recession scenario, in all other cases we expect euro linker demand to remain solid for the rest of 2023 and potentially 2024.”


    But why should hedgers with rising French inflation risk choose euro inflation products?


      “Front-end French CPI swaps have traded structurally rich by about 45bps versus EUR HICPx and underlying inflation dynamics. French inflation has been printing below euro area HICPx in recent years because of differences in energy inflation. Given iota levels, the market will likely aim to obtain substitutes for FRCPIx swaps, with HICPx swaps and OATei being obvious candidates.”


      “Inflation caps with a strike close to ATMF indicate about 40bp as their breakeven level beyond the strike. Similarly, the ATMF 5-year cap-implied volatility has increased substantially from c.1.4% to 2.8% over the last three years, implying a significant premium due to high uncertainty of inflation. More inflation premium = more demand for OATei versus OATs as linkers have a raison d'être.”


    BNPP: Greedy bosses or militant unions – the solution is the same

    Are greedy shareholders and CEOs  keeping inflation high, rather than workers and union bosses? Central bankers such as ECB Chief Economist Philip Lane have begun mentioning profits alongside wages as a factor. And rising oil prices through 2021 and into 2022 were certainly followed by healthy returns for many energy European energy suppliers, not just the producers.


    However, economists at BNP Paribas reckon that it’s not just monopolistic companies using their market power to raise prices and margins that are driving inflation. And, even if they are at least partly to blame, the solution is still tighter monetary policy:


      “While profits are likely to slow as the Eurozone economy loses momentum over the next few quarters, margins matter more for inflation, and there is a risk they widen further.”


      “For the ECB, it should not matter whether profits or wages drive inflation – either requires weaker demand, and distributional concerns are a fiscal policy matter. That said, policy tightening should squeeze profits more than wages, as the former tend to be more sensitive than the latter to rate increases.”