USDi: BEs settle a smidgen higher after surprise BoC rate hike

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BEs settle a smidgen higher after surprise BoC rate hike

Nominals got spooked today after the Bank of Canada jump started its rate hike campaign again today after being the first in the G7 to pause with a surprise 25bps hike up to 4.75%.  “Overall, excess demand in the economy looks to be more persistent than anticipated,” the BoC said in its statement.  And with this, nominals took a bear flattening hit to the tune of 10-13bps this session.

TIPS breakevens manage to get a little beta boost with today’s nominal sell-off with breakevens roughly 1-2bps higher beyond the underperforming 2y sector.  And in the backdrop today, the major domestic equity indices once again struggled (Dow +0.27%, S&P -0.38%, Nasdaq -1.29%) while the energy complex bounced a bit (gasoline +3%, Brent +0.87%, WTI +1.20%).

“TIPS started the day strong again, but outperformance was tempered by the surprise Canadian rate hike,” one dealer explained. “And while breakevens still finished higher on the day, the momentum slowed and most of the day was spent in tight ranges,” he continued. 

Flow-wise in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 240bps, 241.75bps, 242bps and 243.5bps, 2y ZC swaps at 241.5bps, 242.375bps and 242.25bps, 4y ZC swaps at 246.375bps, 5y ZC swaps at 247.375bps, 247.75bps and 248.5bps, 7y ZC swaps at 251.625bps, 10y ZC swaps at 252.875bps, 252.75bps, and 252.375bps, 20y ZC swaps at 248.125bps, 25y ZC swaps at 245.125bps, and 30y ZC swaps at 244bps, 245bps, and 245.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).

Heading into the late close, the 2y breakeven is going out at 212.875bps (-1.25bps), 5y at 218.75bps (+1.625bps), 10y at 222.5bps (+1.5bps) and 30y at 225.5bps (+1.75bps).

BNP Paribas: May CPI data to reveal true core services trend

Strategists at BNP Paribas have already put their pen to paper with an early read on next Tuesday’s May CPI data, highlighting the following key points:

•   We expect modest improvement in the May CPI report, with the headline rate ticking down to 0.1% m/m (consensus: 0.2%, prior: 0.4%) and core CPI slipping to 0.3% (consensus: 0.4%, prior: 0.4%).

   

•   The trend in CPI non-housing services inflation should continue to decelerate (to 5.4% y/y from 5.8% prior), but it remains well above a pace that suggests a return to 2%.

   

•   A turn in categories associated with “revenge spending” (such as airfares, hotels, event admissions and car rentals) drove most of last month’s improvement in non-housing services inflation and could do the same in May. The Fed’s target PCE price index also showed more limited progress on this front than in the CPI. Fed officials are likely to remain wary about sounding the all-clear for the key non-housing services inflation subset.

   

• Looking beyond May, core inflation is likely to moderate as used vehicle and shelter cost inflation subsides. However, we continue to believe a more material weakening in the labor market will be required to return non-housing services inflation – and inflation more broadly – all the way back to target-consistent rates.

In all, BNP Paribas believes that “the May CPI report might reinforce that a turn lower in inflation from high levels – a welcome sign – is distinct from prices being set to converge to 2%.”  As the bank wrote last month, it  thinks that “Fed officials will be hesitant to acknowledge much progress on non-housing services inflation, wanting a more sustained run of evidence before softening their stance.”  As expanded on below, BNP Paribas believes that there are reasons to think non-housing services inflation is “a bit sturdier beneath the surface” :

”…CPI non-housing services to notch further improvement, but with a couple of caveats: Core services excluding rent, OER and health insurance – our preferred way to express non-housing services inflation in the CPI – posted a welcome deceleration in April to 0.2% m/m from 0.5% prior, taking the y/y rate down to 5.8% from 6.4%.

 

“…On a more granular level, we think it is notable that ‘revenge spending’ categories such as airfares, car rentals, hotels and event admissions effectively drove the entirety of April’s downshift in CPI non-housing services. In fact, excluding these categories, non-housing service prices actually ticked higher.

 

“…These categories, which led the post-pandemic rebound in services spending and price gains, may be early in line to cool as well. After all, these are some of the more discretionary pockets of spending that households can afford to minimize if forced to do so. On the supply side, rental cars are more available and air travel load factors are down from their highs, even as traveler throughput is back to norms – both suggest better supply relative to demand.

 

“…’Non-revenge spending’ services categories could prove more resilient, given a still-very-tight labor market and wage growth that remains far above 2% inflation-consistent levels.  

 

“…Beyond this possible divergence between ‘revenge’ and ‘non-revenge’ spending categories, we note that while our CPI non-housing services measure improved in April, its non-housing services PCE inflation counterpart actually ticked higher, on both m/m and y/y bases (though it did edge lower on a 3-month-change basis).

 

“…Relatively stronger healthcare and financial services prices drove the higher non-housing services PCE print in April. The split in April is a reminder that structural differences between the two indices (recall that CPI covers only out-of-pocket spending, whereas PCE covers both direct and covered spending) could drive monthly discrepancies between them. 

 

“…Both of these caveats to the recent improvement in CPI non-housing services inflation should validate Fed officials’ general wariness to sound the all-clear on underlying inflation. That likely means a need to see several months of clear improvement before beginning to soften their inflation stance.”