US Rates Strategy: Erratum: ‘Play the ball‘

Research evidence excerpt

US Rates Strategy: Erratum: ‘Play the ball‘

d implications for oil prices remain the

key near-term risk, given the high empirical correlation between oil and yields observed

recently, and the sharp escalation across multiple fronts observed in the last 24 hours.

Meanwhile, the move at the long end of the curve was significant, especially as the

market priced in a more dovish Fed path at the front end of the curve (Figure 3Theyieldcurvebearstepenedintheaftermathoftoday'sprint). The

jump in longer-run inflation expectations in the aftermath of the meeting does justify

some steepening in the curve, but the 5s/30s curve now appears roughly 7bp too steep

based on a 6-month regression versus 2-year yields and 5Yx5Y inflation expectations

(Figure 45s/30snowapearsroughly7bptostepafteradjustingfor2Yyieldsand5Yx5Yinflationswaps). Notably, while inflation expectations moved higher, 5Yx5Y inflation swaps

rose from cheap levels -- near the lowest of their YTD range -- and are trading at 2.41%,

near the middle of the range and consistent with the Fed's 2% long-run PCE inflation

target (given a CPI-PCE wedge that has averaged near ~30bp historically) (Figure 5).

More importantly, we think the sell-off at the long end primarily reflects a continued rise

in term premium, which is at least partially justified by the removal of forward guidance,

reduction of transparency in Fed communications, and the implications for higher

structural rate volatility. This structural change is coming at a time when duration supply

remains top of mind for investors. While we expect Treasury to retain its forward

guidance next week, signaling unchanged auction sizes for at least the next several

quarters, we recently revised our budget deficit forecasts higher, and we see the supply