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BEs curve flattens while Powell drives point home again
Another upward inflation surprise in the UK today (see Total Derivatives ) likely increases the pressure on the Bank of England and raises the risk of an oversized hike at tomorrow’s meeting. And this prospect put Gilts on the backfoot today which initially leaked into nominals across the pond this session, but yields have come back to near unchanged at the session close (~ +/- 2bps).
Meanwhile, Fed Chair Powell was taking his typical semi-annual grilling in front of the House Financial Services Committee after delivering his prepared remarks this morning. And after his first day of Congressional testimony, Powell didn’t rattle the markets much with new gems of wisdom on monetary policy - outside of more hikes on the horizon.
Against this backdrop, TIPS breakevens and inflation swaps didn’t cover much ground this session (~+/- 2bps) and the front-end gained some support with today’s rebound by higher energy prices (gasoline +0.3%, Brent +1.71%, WTI +2.02%) while longer tenors softened up along with the today’s nominal retracement off their early lows.
Flow-wise in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 234bps, 234.5bps, 238bps, 239bps, 241.25bps and 239.5bps, 3y ZC swaps at 242.5bps, 4y ZC swaps at 245.5bps, and 245.5bps, 5y ZC swaps at 248.5bps, 248.875bps and 249.25bps, 7y ZC swaps at 248.5bps, and 10y ZC swaps at 254.125bps and 254.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Overall, with recent data like yesterday’s much better-than-expected housing data along with Powell driving the Fed’s mantra of “more hikes” and “no cuts on the immediate horizon”, one trader judged that it all solidified the “higher inflation for longer” narrative and that the “market pricing is a bit too optimistic on the inflation going back to 2% in less than 1 year.”
Looking ahead, this week’s TIPS market highlight will likely be the $19bn reopening of the TIIApr28s tomorrow. "With the 5y real yield above 1.80% and the breakeven below 220bps, we expect good demand from end users at tomorrow's auction,” one dealer assessed going in the supply.
Heading into the final moments of the day’s trade, the 2y breakeven is going out at 211.625bps (+2.375bps), 5y at 218.125bps (-0.25bps), 10y at 221.75bps (-0.875bps) and 30y at 224.125bps (-0.375bps).
BofA: More hikes unlikely without persistent inflation; Long 1y inflation swaps
Strategists at BofA believe that 1y inflation swaps (currently trading at 238bps- mid) are not reflecting inflation persistence that would likely underpin need for additional hikes and they view going long 1y inflation swaps as potential way to hedge risk that hiking cycle is not over. BofA expounds below:
- ”… Going long 1y inflation swap is a way to hedge risk that the Fed delivers more hikes given: 1) divergence between 1y OIS and 1y inflation swap, 2) 1y market pricing traditionally underestimates realized inflation.
“…We continue to think that there is a discrepancy between the market conviction in the lack of inflation persistence and the ability to price incremental hikes. The market path of inflation over the next year diverges below our Economics team's expectations most notably in mid-24. We think that inflation pricing will need to be challenged for more hikes to be justified; with expectations for core CPI stepping down to around 0.2%-0.3% starting this summer.”