USD Swaps: Belly-led selloff; Steepener talk

Earlier selloff, volatility erode; Steepener talk

After PPI was a touch higher (0.3% mom/0.8% yoy, ex-food/energy 0.3% mom/2.4% yoy), University of Michigan current conditions came above expectations (77.4 vs. 76.9 forecast) but inflation expectations in the survey were lower (1y at 3.3% vs 3.5% forecast, 5y-10y at 2.9% vs. 3% forecast). With all the data out of the way, USTs are up to 5bps higher in yield, with the 3y-5y sector underperforming the most. Meanwhile equities are mixed (DJIA +0.22%, S&P -0.12% and Nasdaq -0.63%) while TIPS BEs are seeing marginal gains of 1 to 2bps, led by the front end. 

While the prior week had market participants scrambling amid the fierce, unexpected bear steepening, this week saw a retracement back into the range that calmed the market down - helped along by "a nothing burger CPI," sources say - that is, until yesterday afternoon’s somewhat inexplicable bear steepening, which was not entirely accounted for by the tepid, but decent 30y result, some judged.

Thus today’s moderate price action and smaller delivered volatility post-data is likely well received, sources judge. The bear steepening “freaks” people out, explained one source, while "a bull steepening is more understandable as the Fed cuts are priced in."

That said, the August illiquidity is likely exaggerating the impact of any flows that come into the market, sources say, and with some “hedge funds looking to short the back end" - such as Ackman’s pronouncement last week - "any back-end selling is likely to encounter little resistance,” one source remarked.

Elsewhere, swap spreads are seeing modest moves, with the belly slightly narrower while long end spreads are a touch wider amid lower volumes. On the IG new issuance front, yesterday saw a total of $8.25bn priced, bringing the weekly total to $35.15bn - well above the $30bn that was forecast for the week. Month to date for August now stands at just over $50bn, versus the $85bn anticipated for the entire month.  

Looking at the economic data landscape, analysts at BNP Paribas find that yesterday’s CPI release, coupled with the uptick in initial claims, “should support an incremental reduction in the risk of additional Fed hikes – something necessary, in our view, to supporting a more durable shift towards a bull steepening regime.”

“Still, with some of the underlying components likely sufficiently firm to keep the risk of additional hikes alive, we expect the rates market to remain somewhat firm for now in pricing ~10bp through the November meeting,” the bank suggests.

That said, BNP Paribas does “ultimately see an improved risk/reward proposition for curve steepeners, supported by both the cyclical position of the economy as well as upward pressure on duration risk premium.”

Although “spot inflation is showing signs of necessary progress, an uptick in survey-based measures (potentially on the back of higher energy prices) could present a headwind to a steepening bias,” BNPP acknowledges.

2s -11.125bps (+0.25bps), 3s -16.125bps (-0.375bps), 5s -22.25bps (-0.375bps), 7s -29.75bps (-0.25bps), 10s -28.25bps (unch), 20s -64.25bps (+0.75bps), 30s -67.75bps (-0.25bps)*.

*adjusted for the 1bp give.