USDi: PPI feeds hike pause narrative; BEs bear steepen modestly

Chart numbers candles 14 Jun 2022
BEs bear steepened modestly against the backdrop on a softer-than-expected PPI, a nominal rally, lower energy prices.

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  • PPI feeds hike pause narrative; BEs bear steepen modestly

  • Barclays: TIPS became foreign to foreigners


    Click here for SDR inflation swap trade


    PPI feeds hike pause narrative; BEs bear steepen modestly

    Today’s wholesale prices data gave the Fed more food for thought on the disinflation process.  Indeed, on the heels of yesterday’s warmly welcomed CPI release, April PPI came in softer than expected at +0.2% MoM/2.5% YoY versus Bloomberg consensus of +0.3% MoM/+2.5% YoY – fanning the narrative that inflation continues to cool and that the Fed may hit the pause button on rate hikes sooner rather than later.


    However, Minneapolis Fed President Kashkari was quick to step up to the mic today to state that the Fed’s work is certainly still not yet done.  “Inflation has come down but it’s still well above our 2% target,’ Kashkari said today.  “We have seen softening in wage growth nationally, but it’s very mixed.”


    However, traders were likely more interested in the broader backdrop today that saw the FDIC propose that the nation’s biggest bank face billions in extra fees in the wake of the SVB failure (see FDIC) which muffled risk sentiment today (Dow -0.66%, S&P -0.17%, Nasdaq +0.18%) , the resultant duration rally that ended off the morning highs (~ up to 4bps), and renewed weakness in the energy complex (gasoline -1.16%, Brent -1.19%, WTI -1.54%). 


    And against this backdrop, the TIPS breakevens and inflation swaps curves continued to bear steepen this session – though much more modestly than yesterday’s CPI-driven softness.  However, amid the recent correction lower for breakevens, one dealer judged that “in 10y+ maturities, the breakeven range that has defined this sector for a while now should shift moderately lower, but we don’t anticipate wider-scale weakness from these already-low levels.”


    In derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 213.25bps, 2y ZC swaps at 218bps and 218.25bps, 5y ZC swaps at 234.75bps and 234bps, and 10y ZC swaps at 244bps, 2344.875bps and 245.375bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).


    Lastly, Treasury announce today that it will put $15bn reopened 10y TIPS (Jan33s) on the auction block next Thursday (May 18th).


    Heading into the final hour of trade, the 2y breakeven is going out at 194.5bps (-2.25bps), 5y at 211.625bps (-2.25bps), 10y at 217.5bps (-1.375bps) and 30y at 221.125bps (-0.625bps).



    Barclays: TIPS became foreign to foreigners

    Once a year, the markets get an update on foreign holdings of TIPS. The data is released with such a lag (10 months) that has little value from a tactical perspective, but strategists at Barclays think that it is still relevant when assessing the inflation market from a structural perspective.  And within the latest release, the bank finds that “foreign holdings of TIPS declined last year; if structural, we think the Treasury should tread carefully when increasing supply.”  Barclays expounds below:


      ”… The latest release showed a sharp reversal in foreign ownership of TIPS, from $690bn in July 2021 to $616bn in July 2022. Some of the drop can be explained by market moves; the 1-30y Series-B TIPS index fell 6% over this period and hence can explain about $41bn of the $75bn decline. Much of the decline appears to have come from Asian official institutions. Official institution holdings dropped $78bn while overall regional holdings for Asia fell $65bn (there is no official/private breakdown for regions).


      “…On a country level, the biggest shift appears to have come from China, where the market value of TIPS holdings went from $195bn to $142bn. Only about $12bn of the $53bn decline can be explained by market value adjustments. The reduced TIPS allocation was relative as well; TIPS as a share of China’s long-term Treasury holdings fell to 15% from a high of 21% in 2020, the lowest since 2016.


      “…Some of the decline in foreign ownership of TIPS may have been purely a tactical shift that should be viewed as a one-off. For much of last year, the Fed was actively trying to bring inflation down by pushing up real yields, so lightening up on TIPS was arguably a reasonable thing to do. However, if instead it is a sign of a structural shift in foreign allocations to TIPS, it may be important to market dynamics, and the Treasury should take notice in its issuance decisions. In a recent TBAC presentation to Treasury it was noted that “Foreign investment demand remained strong through 2021.” There were already signs that foreign ownership of TIPS had essentially stopped growing over the past few years, and the latest data points to a reversal. Couple this with recent consistent ETF outflows, and we would suggest the Treasury consider increased TIPS auction sizes with a high degree of caution.”