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The market appears to have shifted attention away from CPI numbers, bringing UST yields sharply lower ahead of the data release on Thursday. We broadly agree, noting that there are clear indications that CPI is downshifting, however, with such a sizable move, we are a bit reluctant to chase lower at this point. US CPI has surprised on the downside on the past two occasions and consensus is looking at a 0.0% MoM sa print for headline and 0.3% MoM for core. Average hourly wages, while elevated by historical standards, are also growing at a markedly slower pace compared to last year. This has defused some worries about the very low unemployment rate (3.5%) stoking a wage-price spiral. Meanwhile, inflation swap fixings are pricing in YoY CPI of below 2.5% be end of the year. We think that services side inflation remains critical to watch. With ISM services plunging and wage growth easing, the arguments for rate hikes beyond 5% do not seem compelling at this point.
We remain in the steepening camp and see this playing out in the 2Y/10Y, 5Y/10Y and 5Y/30Y segments over the coming months. A hawkish Fed intent on further weakening the labour market might keep the curve deeply inverted for some time. However, if inflation heads sharply lower, the will to keep rates high would likely shift. We doubt that the USD rates space will continue pricing in stagflation and see a shift into recession pricing and / or Goldilocks would come in the coming months. In both cases, we think that steepening in the 2Y/10Y (towards around -40bps) would take place. For a move towards par and beyond, it would probably require a much deeper slowdown that requires aggressive Fed cuts.
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