USDi: 5y TIPS auction throws BEs a quickly fleeting lifeline

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5y TIPS auction throws BEs a quickly fleeting lifeline

This morning’s barrage of weaker-than-expected data (i.e. jobless claims, Philly Fed, existing home sales, leading index) initially left a bad taste in the mouth of the U.S. inflation asset class. Indeed, with the subsequent nominal rally and souring in risk sentiment after the data hit the tape, TIPS breakevens quickly tumbled in the early trade today with an added assist from even lower energy prices this session.

However, somewhat ironically, the markets ability to successfully digest the heavy weight of today’s $21bn new-issue 5y TIPS auction amid these challenging conditions managed to send the inflation market a lifeline – at least for a bit.  Indeed, the auction was ‘OK’ in all – it stopped 1bps through the 1pm market to draw a stop-out yield of 1.32% but a lukewarm 2.34x bid-to-cover.  Indirect bidders took down 72.6% of the issue while directs claimed 17.2%, leaving dealers with 10.2% of the pie – their highest 5y TIPS allocation since December 2021. 

Nevertheless, while TIPS breakevens went into the auction under pressure – though well off their opening lows – the inflation curve got a nice pop higher once the auction results hit the tape, albeit a quickly fleeting one.  Indeed, breakevens swiftly went offered after their auction-induced bump as risk sentiment turned for the worse early afternoon and they are now heading into the sunset today roughly 1-7bps lower in the 2y-30y sector as the inflation curve resumed bear-steepening amid higher volumes, according to sources.

“While there were the usual gyrations, the end net result was a very modest move lower in breakevens across the curve,” one dealer explained.  “And although this added up to outperformance, given the nominal rally and especially the continuing weakness in energy, I would describe it more noise than signal in the aggregate,” he continued. 

In derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 247bps and 242.5bps, 5y ZC swaps at 252.75bps, 253bps and 253.75bps, 6y ZC swaps at 254.5bps, and 10y ZC swaps at 254.5bps and 254.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).

Looking ahead, with today’s 5y TIPS auction in the rear-view mirror and month-end soon approaching, strategists at Barclays highlight the following ahead of upcoming index extensions:

”… After accounting for the reopening and the TIIApr24s rolling out of the basket, our preliminary projection for the month-end index duration extension of the 1-30y TIPS index is 0.11 years for Series-B and 0.09 years for Series-L. The extension is smaller than last April, largely because the outstanding of the TIIApr24s is notably less than the TIIApr23s, and thus has a smaller impact when rolling out of the basket. We also project the 0-5y TIPS index to extend 0.12 years for Series-B and 0.11 years for Series-L due to the combination of the the high-coupon TIIApr28s rolling into the basket, and the issuance of the new low-coupon TIIApr28s."  

Heading into the final hour of trade, the 2y breakeven is going out at a 247.125bps (-7.375bps), 5y at 288.75bps (-2.5bps), 10y at 227bps (-1.875bps) and 30y at 225.125bps (-1.625bps).

JP Morgan: Hesitant to move off the sidelines and initiate BE longs

Strategists at JP Morgan think that “there is room for front-end breakevens to widen somewhat from current levels,” but caution find that medium-term headwinds and sizeable downside risks leave them sidelined for now.   Indeed, Despite these supportive factors, (e.g carry, improved risk sentiment as the liquidity stress in the banking sector continues to look less acute), the bank is hesitant to move off the sidelines and initiate longs exposure for the following few reasons:

”…First, despite our expectations that inflation will remain some what sticky in coming months, especially with used vehicle prices likely to start increasing again, this is largely reflected in the fixings--as discussed above, with the April fixing implying roughly a 0.43% increase in core.

 

“…Second, while markets now imply roughly an 85% probability of a May hike, in line with our own forecast, and around a 15% probability of a June hike, forwards imply easing to begin shortly thereafter, with over 60bp of easing still priced in for 2H23. Meanwhile, incoming data and Fed commentary appear to be at odds with market pricing, as we think we would need to see significantly more slack in labor markets or a significant amount of tightening in credit conditions—with spillover to the real economy—for the Fed to shift more dovishly. A more hawkish tone from the Fed at the upcoming meeting, relative to market expectations, would be bearish for breakevens.

 

“…Third, and relatedly, while our economic forecasts imply only a gradual slowing in growth and inflation over the course of the year, and the acute phase of banking sector stress appears to be behind us, we acknowledge that downside risks are elevated in the current environment, and bank earnings over the near-term are likely to keep banking sector liquidity and funding issues in focus for now. Against this backdrop, we remain neutral on breakevens, and we will reassess views as we get through front-end supply (this) week.”