EURi: Risk off and oil pull inflation lower

Down chart candlestick 11 Jun 2020
Euro inflation held up OK for much of the day but a risk-off driven rally in duration and a steady slide in Brent futures eventually took a toll.

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  • Risk off and oil pull inflation lower

  • Long RY forward, inflation supported: Banks

  • New issues


    Risk off and oil pull inflation lower

    Euro inflation held up OK for much of the day but a risk-off driven rally in duration through the afternoon as First Republic’s share price lost 30%, combined with a steady slide in Brent futures to an $80.35 low, eventually took a toll.


    Inflation swaps ended 2-3bps lower led by the front end with EUR 5y5y closing just off session lows at 2.43% (-3bps) while EUR 5y fell to 2.54% (-3bps). In the background the Bund rose by more than point, BTPs underperformed, the Euro Stoxx Banks index fell by 2.7% and Brent futures fell by $1.7 to $81. TIPS breakevens also tightened following mixed US data, with the front end of the dollar inflation curve 4-8bps softer.


    A clutch of swap trades on the Total Derivatives SDR today included EUR 4y late in the session at 2.65%, 30y at 2.671% and 2.67%, 5y at 2.54% and 10y at 2.51% in €75m. French inflation traded in EUR/FRF 5y at 47bps and 46.5bps.      


    Later this week, Germany and Spain will announce their upcoming linker auctions. Inflation data start to print from Friday with French HICP seen at 0.5%/6.7% versus 6.7% last month according to the Bloomberg survey, Spanish HICP is forecast at 0.6%/4.1% versus 3.1%, and German CPI is seen at 0.6%/7.3% versus 7.4%.  


    Long RY forward, inflation supported: Banks   

    Barclays this week recommends being long the OAT€i26/29 real yield forward at 0.52% with a stop at 1% and a target of 0%:


      “Although the banking stress will eventually lead to tighter credit conditions, the impact on realized inflation may take some time to play out, and recent ECB commentary has indicated a data-dependent stance (which is inherently backward-looking). We see the combination of these dynamics as putting upward pressure on real yields in the front end in the near term.”


      “However, if our assessment of stabilisation in euro area inflation with growing downside risks the further we look ahead is correct, that would moderate upward pressure on real yields on a forward basis, and potentially lead to a forward cyclical turn over, or at least the market being required to probabilistically price in that scenario. If realized, this is a clear set-up for a real yield flattener bias, or to be long forward real yields.”


      “Moreover, even though (last) week’s OAT€i issuance was further out the curve, the offerings saw strong demand (stopping 2-3bp through mids) at real yields only slightly above the OAT€i26/29 forward. Of course, we are comparing very different duration levels here, but this suggests demand for OAT€i real yields at these levels, which could help richen intermediate tenors as well.”


    Elsewhere, Citigroup sees “little potential” for a large fall in euro breakevens, which it reckons should remain supported by a lack of DV01 supply, perhaps pushing 5y5y “back towards 2.6%.” At the front end, the bank finds it difficult to argue much against current valuations: “1y HICP swaps look only 9bp rich against Citi Economics’ baseline forecast, and all short-dated forwards are consistent with the 2% ECB target + some positive premium.” Citi continues:


      “The inflation outlook remains confusing, with the final March HICP print showing worrisome strength in food prices, slowing core goods inflation, and unclear services price inflation trajectory. In our view, such an uncertainty warrants the inflation premium currently priced in, with stickiness on the way down.”


      “The risk is for breakevens to become negatively directional to monetary policy shocks (shifting from away the typical positive correlation), with hawkish rhetoric and the associated rise in nominal yields pressuring breakeven lower, and with the combination of higher nominal yields and lower breakevens turbo pushing real yields cheaper…Looking ahead, we see little likelihood that a ramp up in hawkish rhetoric (June ECB ESTR cheaper) precipitates 1y1y HICP lower (leaving real yields cheaper).”


    New issues

    • Deutsche Bank launched a €50m (max) inflation-linked note due 4 May 2027. The  EMTN pays 1.3 * euro HICPx inflation floored at 0%. Self-led