USDi: PPI comes in hotter-than-expected; BEs rally modestly

Gas flame blue 11 Oct 2021
PPI came in hotter-than-expected, helping to spark a nominal sell-off that left BEs modestly higher.

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  • PPI comes in hotter-than-expected; BEs rally modestly

  • Barclays: Beta testing the 30y -  Favor 30y 0.7 beta weighted BE longs


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PPI comes in hotter-than-expected; BEs rally modestly

Nominals were buffeted by opposing forces in early trading today. First, after the ECB hiked by 25bps but suggested that rates are likely to stay at current levels for a ‘sufficiently long’ duration to return inflation to the central bank’s 2% target, a 4-6bps fall in yields along the Bund curve briefly supported nominals. 


But the gains were short-lived after US retail sales (+0.6%) and PPI (+0.7%) both printed higher than expected, putting nominals on the backfoot with yields ending roughly 3-4bps higher this session.


Against this backdrop, TIPS breakevens and inflation swaps opened up better bid in a move once again led by the front-end of the inflation curves.  And amid various fits and spurts of buying/selling intraday, a choppy trade is seeing them close out modestly higher (~ up to 1.5bps) against a buoyant risk backdrop (Dow +0.96%, S&P +0.84%, Nasdaq +0.81%) and continued strength in energy prices (gasoline +0.25%, Brent +2.27%, WTI +2.21%).


“After an early bid and spike for breakevens, they traded better offered all day, in similar mood as yesterday afternoon, giving back early performance,” one dealer explained.  “While today’s data should have been positive for breakevens, sellers had the upper hand and breaks closed their eyes on the 1% rise in energy and on the duration sell-off,” he continued. 


Meanwhile, in derivatives-space, one dealer shared that "the basis was bid all day showing some decent swap buying activity taking advantage of this breakeven pause".  Flow-wise, swap trades on the SDR today included 5y ZC swaps at 261.375bps, 260.625bps and 259.625bps, 10y ZC swaps at 262.625bps, and 30y ZC swaps at 256.75bps (for all of today’s trades, see Total Derivatives SDR, which now also includes information on broker/platform).


Lastly, on the supply front, Treasury announced that it will put $15bn re-opened 10y TIPS (Jul33s) on the auction block next Thursday (Sept. 21st).


Heading into the final hour of trade, the 2y breakeven is going out at 224.375bps (+0.625bps), 5y at 231bps (+1.375bps), 10y at 234.375bps (+1.5bps) and 30y at 234.5bps (+1.5bps).



Barclays: Beta testing the 30y -  Favor 30y 0.7 beta weighted BE longs

Strategists at Barclays believe that 30y real yields above 2% may bring back long-term structural cross-asset real return investors, and TIPS may begin to lag in further sell-offs. Meanwhile, the bank believes that 30y breakevens are already fundamentally cheap, and are unlikely to fall much in rallies. Combining these views, Barclays recommends 30y 0.7 beta weighted BE longs, and it expounds on its view below:


    ”…Topping 2% may be the tipping point - In the rates sell-off since late July, we have been discussing two themes with regard to the long end of the TIPS curve: 1) for many of the same reasons plus others, a higher real term premium is justified, as is a higher inflation risk premium, and 2) 30y real yields back above 2% for the first time since 2011 may begin to draw back in some long-term structural cross-asset real return investors that left the TIPS market when 30y real yields fell as a result of the Fed's operation twist. While 30y real yields have risen more than 40bp from late July, 30y breakevens have traded in a relatively tight range centered around 2.3% – a level consistent with the Fed perennially undershooting its inflation target. This combination has meant that while breakevens have not traded poorly on an outright basis, they have significantly underperformed on a beta adjusted basis


    “…The underperformance of long-end breakevens adjusted for the move in real yields has also occurred in long forwards, with 10yfwd20y real yields also recently topping 2% even as long forward breakevens remain at levels which point to the Fed missing its target to the downside. That 30y real yields are above 2% not just because short spot rates are high but longer forwards as well should make structural real return investors that much more interested in re-engaging with 30y TIPS. This potential demand does not mean that 30y real yields cannot rise further, but it may cause real yields to begin to lag bear nominal moves. The supply outlook, where the Treasury is increasing 30y nominal issuance but is unlikely to raise TIPS auction sizes, also supports this view. However, in rallies, except severe ones, we would expect real yields to continue to trade with a very high beta because breakevens are already fundamentally low, in our view. To position for 30y real yields to lag in sell-offs and keep up in rallies, we recommend being long 30y breakevens with a 0.7 beta.”