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No beta to be found for BEs; Heavy into month-end
The most salient aspect of an otherwise light summer trade amid a dearth of meaningful news flow was the batch of stronger than expected data this morning that set the tone for the entire session today.
To be sure, an unexpected jump in durable goods orders (+1.7% versus -0.9% Bloomberg consensus), stronger than expected new home sales (+763k versus +675k Bloomberg consensus) and higher than expected consumer confidence 109.7 versus 104 Bloomberg consensus) put nominals of the backfoot all day today (~ 3-8bps) after a largely rudderless overnight/opening trade.
However, against this backdrop, TIPS breakevens failed to make much of the nominal sell-off in a utterly beta-less trade as the inflation curve modestly compressed today despite a buoyant risk tone in the backdrop (Dow +0.63%, S&P +1.15%, Nasdaq +1.65%).
However, dealers note that the heaviness in the inflation asset class already started last Friday with Thursday’s solid 5y TIPS auction seeming “already very far” from the mind of market participants. “Off the runs started to be offered, materializing the pressure from the end of month rebalancing flow even if we’ve still got days to go,” he continued.
Flow-wise in derivatives-space, inflation swap trades on the SDR today included 1y ZC swaps at 241bps, 5y ZCs swaps at 240bps and 244.75bps, 10y ZC swaps at 251.75bps, 250.875bps and 251.125bps, 15y ZC swaps at 250.875bps, 20y ZC swaps at 247.625bps and 30y ZC swaps at 243.25bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).
Looking ahead, on Friday, which is month-end, Bloomberg estimates that the duration of the Series-B and Series-L 1-30y TIPS indices will both contract by 0.03 years.
Heading into the final hour of trade, the 2y breakeven is going out at 203.25bps (+0.125bps), 5y at 215.125bps (-0.75bps), 10y at 219.5bps (-0.625bp
Deutsche Bank: Minding the 2y and 5y5y TIPS rates gap
Strategists at Deutsche Bank recently explored approaches to identifying a sufficiently restrictive Fed policy stance, based on policy rules, financial conditions indices, and market pricing. One of the market measures the bank considered was the gap between 2y and 5y5y TIPS rates, explaining that ”the rationale for this ‘real rate gap’ as a measure of policy restraint is that 2y TIPS reflect the expected average real policy rate over the cycle, while 5y5y TIPS are a market proxy for expected r-star. The gap between these is a natural gauge of the policy stance priced by markets.” Deustche Bank expounds on its findings below:
- ”… A key limitation is that TIPS have only traded actively since 2004, restricting comparison of the current gap to levels reached in earlier hiking cycles. To address this, we ‘backcast’ TIPS yields into pre-2004. Specifically, we (1) take the first three principal components (PCs) of the nominal yield curve since 2004 (dropping crisis periods in 2008 and 2020); (2) regress 2y, 5y, and 10y TIPS on these PCs; and (3) use the regression estimates and pre-2004 PCs to obtain fitted values for 2y and 5y5y real rates in the pre-TIPS period. The result: a time series of the 2y-5y5y real rate gap that stretches back to the early 1970s.
“…Using this approach we find the current 2y-5y5y gap of around 1.45% is as high as it’s been since 1980, suggesting the market is pricing a path of Fed policy that is arguably sufficiently restrictive. Some other market- and FCI-based measures we considered suggest the same. That said, this historical benchmarking could prove wrong and greater conviction around sufficiently restrictive will come from clearer evidence that inflation is moderating and tightening in bank lending conditions is restraining activity…We expect to see this over coming quarters.
“…Finally, a decline in the 2y-5y5y real rate gap from its current historical high would be the real-side counterpart to our forecast that the nominal curve will steepen out by year-end as recession and Fed rate cuts approach. Our recommended forward 2s10s steepener and 5s10s term premium payer are together positioned precisely for this on the nominal side.”