USDi: 10y TIPS auction devoured by Indirect bidders

• 10y TIPS auction devoured by Indirect bidders

• SocGen: Have real yields peaked? Long 2y TIPS

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10y TIPS auction devoured by Indirect bidders

For those who thought that the recent declines in the CPI would hinder the demand for USD inflation protection, today’s $17bn 10y TIPS auction definitely put that theory to rest. 

To be sure, the newly-minted 10y TIPS (Jul33s) auction stopped 6 basis points through the 1pm WI yield, drawing a stop-out yield of 1.495% and a solid 2.51x bid-to-cover.  Indirect bidders stepped up to the plate and took down a record 85.8% of the issue while directs took down 12.7%, leaving dealers with a miniscule 1.5% of the issue - yet another new record low by a sizeable 6.1% margin.

So, it was no doubt a well-received auction. But the U.S. inflation asset class was already setting up for a good day today as TIPS breakevens were already pushing higher into the auction off the back of a roughly 6-12bps sell-off in nominals after this morning’s strong jobless claims data (+228k versus +240k Bloomberg consensus). 

And with the dust settling on today’s trade, dealers are marking the breakeven curve roughly 5-8bps higher against the backdrop of mixed risk sentiment (Dow +0.47%, S&P -0.69%, Nasdaq -2.05%) and modestly higher energy prices (gasoline +1.04%, Brent +0.26%, WTI +0.37%).

“We started the day on the bid side coming from the short term and we stayed that way almost all day… the only pullback was the small post auction action with some profit taking,” one dealer explained. “With the yield sell off, real yield buyers did not care much about breakeven and the performance is impressive,” he continued.

Flow-wise in derivatives-space, swap trades on the SDR today included 1y ZC swaps at 215bps and 218bps, 2y ZC swaps at 225.25bps, 3y ZC swaps at 229.75bps, 234.5bps and 235bps, 4y ZC swap at 238.875bps, 5y ZC swap at 245.75bps, 246.75bps and 252bps, 9y ZC swaps at 255.5bps and 257.75bps, and 10y ZC swap at 255.5bps, 256.375bps, 256.625bps and 260bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).

Lastly, as today’s Jul33 TIPS offering gets included in the 1-30y TIPS index and the $41bn ($33bn ex-SOMA) TIIJul24s drop out, Barclays estimates the month-end duration extension at about 0.25 years. 

Heading into the final hour of trade, the 2y breakeven is seen in the screens at 195.75bps (+6.125bps), 5y at 224.375bps (+9.125bps), 10y at 231.75bps (+8.625bps) and 30y at 231.5bps (+7.125bps).

SocGen: Have real yields peaked? Long 2y TIPS

Strategists at SocGen believe that real yields may have reached their highs for the cycle and the recent rally has room to continue. Thus, with the Fed likely near the end of the hiking cycle and inflation likely to average above 2.5% over the next two years, SocGen recommends going long 2y TIPS.  The bank expounds on its view below:

”… After rising for three months, real yields reversed (last) week. The rally in TIPS followed a slightly soft payrolls report and continued CPI cooling in June. We believe real yields may have reached their highs for the cycle and the recent rally has room to continue. With the Fed likely near the end of the hiking cycle and inflation likely to average above 2.5% over the next two years, we recommend going long 2y TIPS.

 

“…The selloff in TIPS since April was largely driven by the market re-pricing of Fed cuts out of 2023 even as inflation moderated. The fed funds futures market is now in line with our expectation of one more hike and no cuts this year. Meanwhile outflows from TIPS ETFs have continued in recent months, helping push real rates higher. The outflows from TIPS could reverse quickly if inflation proves stickier than expected and the Fed signals rate hikes are over. Primary dealer positioning in 2y-6y TIPS reached new highs last week, with end-users reluctant to buy off-the-run TIPS despite relatively strong demand at recent auctions. We believe this presents an opportunity in the 2y sector, as real yields in the shorter-maturity TIPS appear high. Since March 2022 the 10y real yield has diverged from the price of gold. TIPS and gold are both assets that diversify against inflation and low real economic growth. It would not be surprising to see them converge again if inflation is sticky and growth disappointing.”