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BEs gain a lift from energy despite nominal rally
A solid rebound in the energy complex (gasoline +3.18%, Brent +3.36%, WTI +3.43%) after yesterday’s dip and a buoyant risk tone (Dow +1.26%, S&P +1.22%, Nasdaq +1.15%) help lift USD inflation today – despite a 3-8bps rally in nominal after investors zeroed in on this morning’s higher than expected jobless claims data (+262k versus +245k consensus). The front-end of the TIPS breakeven and inflation swaps curves spearheaded today’s modest advance amid relatively light volumes.
Flow-wise in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 234.75bps, 237bps, 236.75bps, 235bps and 236bps, 5y ZC swaps at 248.25bps and 10y ZC swaps at 253.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Lastly, Treasury announced that it will put $19bn re-opened 5y TIPS (Apr28s) on the auction block next Thursday (June 22nd).
Heading into the final minutes of trade, the 2y breakeven is going out at 221.375bps (+3.875bps), 5y at 220.625bps (+2.625bps), 10y at 223.5bps (+1.875bps) and 30y at 223.875bps (+0.25bps).
Barclays: Playing in the band; 5y5y versus 10yf20y BE curve steepeners
Last week, MNI reported that the Fed may be considering shifting from a single point target of 2% on PCE inflation, over time, to a band system, such as 1.5-2.5%. Below, strategists at Barclays share their view on this potential shift as well as a position to benefit from what they view as cheap insurance:
- ”… . If on average over time inflation was at the mid-point of this range, then there would likely be little practical difference between a point target and a target range. Additionally, the Fed has consistently shown patience when inflation was “within hailing distance” of its point target, to quote former Fed Vice Chair Fischer, and thus its reaction function already implicitly incorporates tolerance bands, at least temporarily. The main risk with adopting increased tolerance away from the mid-point of the band during sustained periods when the Fed has struggled to get inflation up to or down to its point target is that structural inflation expectations may be pulled up or down by recent experience. Pre-pandemic, when the Fed, on average, missed to the downside and showed patience with perennially below-target inflation, eventually longer forward market-based inflation compensation (breakevens) fell to levels that were consistent with inflation staying structurally below 2% on PCE. Adoption of a range during that period would have likely only solidified what the market was already pricing.
“…If the Fed were to adopt such a range now, when it has struggled to bring inflation down, market participants might interpret the shift as one in which elevated inflation is more tolerated. Structural PCE inflation at the top of the range might be seen as acceptable, and, for example, 2.8% might be viewed as “within hailing distance,” essentially allowing an implicit perceived creep up in the target, and we would expect forward breakevens to follow. Despite the many investors who tell us that structural inflation risks (such as de-globalization and energy transition costs) are to the upside and the Fed is likely to be tolerant of higher inflation going forward (as a shift to a target range might signal), longer forward inflation compensation remains at levels consistent with the Fed hitting its 2% PCE target (breakevens slightly below, CPI swaps slightly above), and it has been in a fairly tight range for at least the past six months. Additionally, the 5y5y vs 10yf20y forward inflation curve is essentially flat in breakeven space and inverted in CPI swaps, and this too implies there is little to no positive long-term inflation risk premium priced in. As a position to benefit from what we view as cheap insurance, we continue to recommend 5y5y versus 10yf20y breakeven curve steepeners.”