USD Rates: Digesting inflation


Extend SGD rates outperformance over USD rates to longer tenors
Eugene Leow14 Oct 2021
    Photo credit: Unsplash Photo


    USD rates took CPI data and Fed minutes in stride. Headline CPI (at 0.4% MoM sa) was a tad higher than consensus estimates of 0.3% while core inflation was in line at 0.2%. On a three-month annualised basis, we note that inflation momentum has finally moderated. Price pressures that we saw at the start of the year were clearly not sustainable as a large chunk was contributed by used car and truck prices due to supply issues. This component is moderating. Meanwhile, there is some broadening in price pressures, but nothing to suggest that inflation is a problem serious enough for the Fed to aggressively frontload tightening. That said, with the surge in energy prices over the past few weeks, reopening components in the CPI basket moderating at a slow pace and wages rising, it is difficult to envision inflation being transitory. Inflation could well stay elevated some time and this is also reflected with the 10Y breakeven closing above 2.5%. All eyes will be on PPI figures due later. 

    Fed minutes reiterated that normalisation is imminent, which officials considering a taper start in either mid-November (shortly after November’s FOMC meeting) or in mid-December. This is in line with a view we have held since early 2021. The pace of reduction would likely be USD 15bn per month, setting the stage for taper to be completed in June/July 2022. This sets up a potential rate hike as early as 4Q22. 

    We think that the market has looked past taper and is now looking at the upcoming hike cycle.Note that the US Treasury curve flattened aggressively over the past two trading sessions. A lot of it is driven by the 30Y tenor, where yields fell by 13bps. We remain in the bear flattening camp over the coming quarters noting that this phenomenon tends to play out ahead of Fed hikes. Upward pressure is likely to be more apparent in the 2Y-5Y tenors as the market prices in rate hikes. Meanwhile, we are more neutral on 10Y yields at current levels, noting that this rate is already in the lower part of the 1.5-2.0% pre-pandemic range. Pay positions on 10Y would probably be interesting only if the yield falls to 1.50% or below. 30Y yields are close to our fair value floor of 2%. Auction demand was strong as investors probably took the chance to buy after a barren summer when yields were depressed. At 2.03%, we think 30Y UST looks a bit rich.   

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]
     


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