USDi: BE curve continues breaking steeper as banks remain on shaky ground

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BE curve continues breaking steeper as banks remain on shaky ground

USD inflation closed out with mixed results on the curve with the only constant being continued steepening today against the backdrop of more angst on the regional banking front. 

Indeed, despite refuting FT claims that it was considering a potential sale of all or parts of its business, Western Alliance Bancorporation remain under the gun today with its share tumbling another 41% - only to be outdone by Pac West shares which fell an additional 48%.  And once again this continued chaos and uncertainty spoiled the mood in the broader markets that saw all the major domestic equity indices on the ropes today yet again – but ending well off their earlier lows (Dow -0.86%, S&P -0.72%, Nasdaq -0.49%).

Against this backdrop, along with nominals coming off their intraday highs that posted at the apex of concerns late morning to end the session mixed (+/- 5bps), the TIPS breakeven and inflation swaps curves continued to bend even steeper as shorter/intermediate tenors remained bidless while the longest tenors eked out modest gains. 

“Chaotic day in the US inflation market with the net result a lower and steeper breakeven curve, matching the overarching theme that has dominated the week,” one dealer explained.  “While the first few hours were rather rangebound, the eventual risk-off mood sent breaks straight down” and  “larger illiquid swings in either direction followed with some buying at the day's lows but decidedly mixed after that,” he continued. 

In derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 220bps, 221bps, 218bps, 217bps, 215bps and 216bps, 2y ZC swaps at 219bps, 220.5bps and 221bps, 5y ZC swaps at 238bps, 10y ZC swaps at 248bps, 25y ZC swap at 238.875bps and 240.5bps, and 30y ZC swaps at 239.25bps and 240.5bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).

Heading into the final stretch of today’s trade, the 2y breakeven is going out at 196.25bps (-5.125bps), 5y at 214.625bps (-1.875bps), 10y at 218.75bps (-0.125bps) and 30y at 221bps (+1.875bps).

JP Morgan: TIPS TBA commentary

TBAC’s letter to Treasury yesterday noted the “Committee recommends Treasury begin increases to TIPS particularly in the front end at the next new issuance for each maturity point, but closely monitor performance to ensure the supply is being well received. The Committee also recommends further study on the mix of TIPS issuance, the possibility of increasing the number of issues per year, and potential support for an additional front-end point.” The letter goes on to emphasize the recommendation to arrest the decline of the share of TIPS in outstanding debt. Moreover, the TBAC meeting minutes noted that dealers did not expect any changes in TIPS auction sizes this quarter but expected marginal increases in FY24, and also mentioned that Committee members emphasized the importance of monitoring market conditions.

Between the lines, strategists at JP Morgan “sense somewhat more hesitation on the part of Treasury, relative to TBAC, in moving forward with increases to TIPS auction sizes, which was evident coming out of the February refunding process as well.”  Against this backdrop, the bank continues “to forecast gradual auction size increases, beginning with the 5-year TIPS new-issue auction in October, although we recognize Treasury would likely be responsive to any weakening in investor demand in coming months. “  Combining this with its projections for increased net nominal Treasury issuance,  JP Morgan project that “the TIPS share of outstanding debt will hover under 8% over coming quarters, well below pre-pandemic levels.”  Below JP Morgan highlgihts other key points:

”… Within the details of the charge question itself, the presenter highlighted many of the same themes that have been discussed by TBAC in the past when considering the benefits of the TIPS program as part of Treasury’s debt management strategy.  TIPS are a natural hedge for Treasury, as the budget deficit tends to rise during periods when inflation falls, and therefore falling TIPS interest costs in a downturn can help to offset the costs of higher deficits.  A TBAC study from 2018 showed that total deficit volatility is reduced for TIPS allocations up to 13% of the debt stock. While noting that debt optimization decisions should not be overly sensitive to fluctuations in market pricing, the presenter suggested that the ex-ante TIPS advantage has increased in the last couple of years, given the rise in inflation risk premium versus 2019-2020 levels, as proxied by 5Yx5Y breakevens relative to survey-based measures of inflation expectations. 

 

“…On the demand front, structural support for the program remains strong, as end-user demand at auction across maturity points continues to average near historical highs, suggesting the market can accommodate issuance increases in a regular and predictable manner ( Figure 4). We agree with the presenter that retail TIPS fund outflows over the past year are likely to reverse course alongside positive price returns. However, it’s worth noting that the presenter’s discussion on foreign demand was based on data through 2021, and the latest annual TIC data showed a further reduction in TIPS holdings by foreign official investors. Overall, we expect Treasury will continue to monitor conditions in the TIPS market and perhaps engage in further study of the appropriate calibration of the TIPS share of debt.”