USDi: BE rise into CPI; Front end leads

Chart lines Oct 2022
BEs rose ahead of CPI tomorrow, with the front end seeing some better buying and some see BEs are roughly fair. Barclays likes buying 2y BEs still.

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  • BE rise into CPI; Front end leads  

  • 2y BE long still look attractive – Barclays  

  • CPI preview – Deutsche  

    Click here for SDR inflation swap trades


    BE rise into CPI; Front end leads  

    Against a modest bear flattening in nominals, rising energy (Brent 1.6%, WTI +2.11% and NYH gasoline 1.73%) and a stable risky asset backdrop (DJIA +0.29%. S&P +0.04% and Nasdaq -0.43%), TIPS BEs saw a flattening move with the front-end leading gains, with demand from end users and the dealer community, sources say. CPI NSA dealt at 302.225 or a little lower compared to the previous prints, sources note.


    Looking at the recent price action in BEs, one source noted that last week for the first time in a while that TIPS lagged versus the underlying nominal rally. “It was nice to see the TIPS market react to growth forecasts rather than just what the Fed is going to do rate hiking wise,” one trader remarked.


    Going into CPI, the source added that tomorrow’s print should see the headline less than the core print, and should inflation come in, then that will be a “tailwind for the consumer” - should average hourly earnings not drop as much. Overall, the source felt that BEs were roughly fair, but that BEs would be more subject to overall risk sentiment – thus should risky assets sour, then BE would likely suffer.    


    Flow-wise, inflation swap trades included 1y ZC swap at 274.75bps, 2y ZC swap at 254bps, a switch of 1y ZC swap versus 2y ZC swap at 275.5bps and 254.275bps, respectively, 5y ZC swap at 255.5bps, a fly of 10y/20y/30y ZC swaps at 255bps/244.5bps/240.75bps, a switch of 30y ZC swap at 240.85bps versus 25y ZC swap at 240.625bps, according to the SDR.


    Going into the close, the 2y breakeven is at 267.5bps (+4.5bps), 5y at 242.5bps (+1.9bps), 10y at 229.25bps (+1.7bps) and 30y at 224.5bps (+1.7bps).


     2y BE long still look attractive – Barclays

    Analysts at Barclays continue to recommend TIIApr25 breakeven longs, “in part because it expect near term inflation prints (and hence carry on breakeven longs) to be supported by a still-robust trend in rents and OER.”


    Indeed, Barclays notes that “shelter CPI remains close to its peak run-rate and has yet to show signs that it is about to head lower.”  While “leading data point to a significant slowing in H2 23,” Barclays points out “there is considerable uncertainty as to how quickly that downshift will be realized and where it will bottom.” For example, it notes that “recent data show Shelter CPI is slowing, but not below the level that is already priced into markets.”


    Thus, “combined with a likely bounce in used car CPI in the coming months, and slower but still-strong wage growth, we believe 2y breakeven longs continue to have value.”


    CPI preview – Deutsche  

    As for tomorrow’s CPI, analysts at Deutsche Bank see a +0.39%mom/+5.6%yoy print for core keeping three-month annualized (5.1% vs. 5.2%) and six-month annualized (4.7% vs. 5.1%) core inflation rates well above the Fed’s target. 


    At the component level, Deutsche views that “much of the softness in core goods has been a function of recent large declines in used cars and trucks.” Indeed, it finds that “while core goods prices as a whole were flat in February, prices for goods outside of used cars and trucks actually rose by 40bps.” In coming months, Deutsche forecasts continued strength in rents and it expects the “large” increases in wholesale used car prices (up about 9.4% since November) to make their way into the CPI, implying that inflation may continue to exceed the Fed’s baseline expectations.


    As to services, Deutsche expect rents “to remain strong and medical services to drag, similar to their behavior over recent months.” Regarding core services excluding rents and health care, the bank finds much of the strength in February “was due to a 6.4% surge in airfares.”  Overall, Deutsche finds “it is clear that the Fed's interest rate hikes have yet to impact the trend in this labor-sensitive category” and “if anything, things seem to be going the other way, with the year-over-year rate in this category increasing by 20bps to 7.6%.” As a result, Deutsche asserts “this is the major reason we expect the Fed to hike rates again at the May meeting by 25bps to 5.1%.”


    For more CPI previews, please see Total Derivatives.