Click here for SDR inflation swap trade
Debt ceiling impasse catches up with BEs
Nominals shifted back into bear flattening mode as the clock continued to tick on finding a resolution to the debt ceiling impasse with no deal in sight, sparking an over 100bps rise in front-end T-bills while 2y note yields rose all the way up to 4.39% at one point.
Meanwhile, news from the May FOMC minutes that Fed officials were split on whether more rate hikes were warranted, and hinting that the June decision is shaping up to be a toss-up between a temporary pause or another hike was met with little fanfare in nominals. Into the close, the nominal 2y note yield is last 9.5bps higher at 4.359%, or 9.5bps higher, while the 2s10s spread is 5.6bps narrower (give adjusted) at -63.3bps.
And against this backdrop, the U.S. inflation market failed to brush off today’s developments as well as it held up yesterday – despite a continued rally in the energy complex today (gasoline +1.93%, Brent +1.47%, WTI +1.33%). Indeed, today dealers are marking TIPS breakevens and inflation swaps lower across the board as today’s broader risk-off move surrounding the debt ceiling won out today’s round (Dow -0.77%, S&P -0.73%, Nasdaq -0.61%).
“Yesterday's real yield rally was revealed as a head fake for today, at least as opening strength in TIPS was quickly sold and breaks spent the rest of the day trending lower and lower,” one dealer explained. “Combined with the nominal selloff that led to a bear flattener in real yield with the frontend under renewed relative pressure after a run of recent outperformance.”
In derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 237bps and 235.75bps, 2y ZC swaps at 237bps and 237.5bps, 5y ZC swaps at 244.5bps, 8y ZC swaps at 254.25bps, 10y ZC swaps at 255bps, 12y ZC swaps at 254.75bps and 254.875bps, and 15y ZC swaps at 254bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Heading into the final hour of trade, the 2y breakeven in going out at 214bps (-0.625bps), 5y at 218.625bps (-3.5bps), 10y at 226.125bps (-2.125bps) and 30y at 231.75bps (-1bps).
HSBC: Buy 5Y TIPS - Attractive value versus range outlook
Strategists at HSBC have turned “more constructive” on 5y TIPS given the change in valuation versus earlier this month, noting that “this shift reflects the move to the upper end of the recent trading ranges for a number of points on the nominal and real yield curve.” HSBC expounds on its view below:
- ”…Our near-term risk versus reward view is based on the yield range after the SVB failure. A second review considered the risks for a shift in the Fed outlook back to the higher for longer narrative in March 2023 (before SVB) and an inflation uptick, reflected in the October/November yield spike levels.
“…The five-year TIPS yield is near the upper end of its post SVB range, and the 30 June forward provides an additional cushion.
“…This yield peaked in the 1.9% area for our risks cases, +45bp versus the forward.
“…In contrast, the five-year US Treasury yield is near the middle of its recent range and it peaked in the 4.4% area, +90bp to the recent level.
“…The risk to our view is an upside surprise to longer-run inflation expectations. Five-year sector nominal and real yields were higher in March 2023, when the Fed narrative was a higher for longer funds rate on sticky inflation fears. They were also higher in October/November of last year, when investors questioned the Fed’s longer run inflation fighting resolve.”