Click here for SDR inflation swap trade
Fed wins latest round on inflation with April CPI
Looks like the Fed has won the latest round in its fight on inflation that seems to be losing some of its breath – though certainly not down and out just yet. To be sure, headline CPI came in at +0.4% MoM/+4.9% YoY (versus Bloomberg consensus of +0.4% MoM/+5% YoY) while core came in as expected at +0.4% MoM/+5.54% YoY. Meanwhile, the NSA came in a tad softer than expected at 303.363, compared to consensus of 303.5 and a fixing market in the screens of 303.54.
Digging into the finer details of the release, strategists at BofA highlight the following:
- ”… There was some good news within the noncore components. Specifically, food prices were unchanged for a second consecutive month as food at home prices fell for a second consecutive month suggesting grocery bills are beginning to decline. Meanwhile, energy prices rose by 0.6% m/m, which was below our expectations, as energy services fell (-1.7% m/m) more than we expected.
“…Meanwhile, core inflation rose by 0.4% m/m (0.41% unrounded), in line with consensus and a little stronger than our expectations (0.34%). Core inflation continues to move sideways. While the y/y rate did tick down a tenth to 5.5%, it's printed at 5.5% in three of the last four months. Additionally, on a three-month annualized basis core CPI rose by 5.1%, unchanged from March. In short, at the top-line level, core inflation remains stubbornly high.
“…That said, we think the details of the report are encouraging. First, the 0.4% m/m print was driven by a 4.5% surge in used car prices, its first increase since last June. This accounted for 14bp of the core increase. We think the Fed can look through some of this increase as wholesale prices fell sharply in April after four consecutive advancing for four consecutive months.
“…Indeed, used car prices were also the main driver of core goods inflation (+0.6% m/m). Core goods excluding used cars rose by just 4bps, its lowest reading since February 2021. This reflected deflation in household furnishings, new cars, other recreational goods, and education and communication goods. While this is just one month of data, it could be the start of broader goods price deflation given the improvement in supply chains and softening demand.
“…Core services inflation, meanwhile, rose by 0.4% m/m, roughly in line with our expectations. Rent and owners' equivalent rent (OER) both rose by 0.5% m/m, suggesting that the moderation seen in March has some staying power. While inflation of 0.5% for rent and OER is still well above pre-pandemic levels, asking rent data continue to suggest further moderation over the course of the year.
“…Core services excluding rent and OER, meanwhile, slowed from 0.4% m/m in March to 0.1% m/m in April, which is positive news for the Fed. As we had flagged in our preview, lodging away from home and airfares both declined sharply on the month. Education and communication services inflation also moderated from 0.3% m/m to 0.1%. However, motor vehicle insurance remained sticky-high, increasing by 1.4% m/m and recreation services prices rose by 0.7% reflecting a 2.7% increase in pet services prices. On a three-month annualized basis core services ex rent and OER rose by 4.2%, down from 5.2% in March. While this is still too high, the April data are certainly a step in the right direction.”
Following the release, both the TIPS breakeven and inflation swaps curves bear steepened sharply as the NSA print was below Bloomberg consensus of 303.5 as well as the fixing market of 303.54 heading into the print. Notably, both the 1y and 1y1y inflation swaps are now at if not below the Fed's target accounting for the historical wedge between CPI and PCE. And looking ahead, BofA believes that “end of cycle long duration trades are better placed in TIPS given the very limited inflation risk premium currently priced.”
“While not a large miss on the surface, the CPI data revealed softening pressures in enough key components to send breakevens sharply lower at the front end of the curve,” one dealer explained. That said, he judged that “the repricing of the front is probably overdone and while of course it can go lower, when the dust settles further there should be buying interest.” Moreover, he noted that “the price action and accompanying flows were mostly one-way, with fast-money selling in the immediate aftermath and very few dip buyers even as we plumb the lows here late in the day.”
In derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 220bps, 2y ZC swaps at 219bps, 219.25bps and 218bps, 3y ZC swap at 226.5bps, 4y ZC swap at 233bps, 5y ZC swap at 240.25bps and 240bps, 10y ZC swap at 247.875bps, and 30y ZC swap at 242.625bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Lastly, tomorrow, the Treasury will formally announce this month’s 10y TIPS reopening (Jan 33s), which Barclays expects to be for $15bn.
Heading into the final hour of trade, the 2y breakeven is quoted at 198bps (-15.5bps), 5y at 214.625bps (-8bps), 10y at 219.25bps (-4.25bps) and 30y at 222.25bps (-1.625bps).
JP Morgan: Upside limited for BEs
Strategists at JP Morgan believe that “any upside (to breakevens) is likely to be limited, especially as growing downside risks on the macro front suggest that we could see breakevens narrow materially into next month.” The bank expounds on its bearish view below:
- ”… Importantly, we now estimate that Treasury will run out of resources under the debt ceiling by June 9, two months earlier than our previous estimate, while Treasury Secretary Yellen warned Congress that she estimates the X-date to be on June 1. This leaves a very narrow path for Congress to reach a resolution and avoid a technical default, with negotiations (kicked off this) week. As our economists have noted, even a last minute deal could have ramifications for the real economy, while a technical default could drive the US into severe recession.
“…In addition to this, the debt ceiling debate will be taking place while the regional banking sector remains vulnerable to further weakening in sentiment. In an environment in which profitability issues continue to weigh on regional banks, a chronic phase of credit contraction is, in a sense, the best case scenario, while a more rapid contraction alongside further bank failures remains an important downside risk in the near term.”