Goldman: Sell 1y1y TIPS

Goldman Sachs note that “the softer than expected March core CPI print obscured generally firmer details amid an outsized drag from used car prices. While the 6.5% increase likely reflects a peak in year-on-year inflation, upside risks to the inflation path remain amid tight labour markets, already firm core services inflation, and ongoing concerns about the potential for further supply bottlenecks (due to either the war in Ukraine or COVID lockdowns in China). With a labour market backdrop that may require tighter conditions that slow growth to a modestly below trend pace, our economists have noted upside risks to the terminal rate forecast of 3-3.25%, leaving the case for real yield shorts still in place despite the already significant selloff this year (our recommendation to be short 5-Year TIPS hedged with long oil hit its trailing stop last week, and we closed this for a potential gain of 53bp). Intermediate forward real yields have converged towards more reasonable “longer run” levels, with 5y5y TIPS yields around 0.3-0.4% and the forward real curve relatively flat beyond the 2-Year point. However, 1y1y real rates are around -0.25%, having retreated from local yield highs amid the front-end led rally. In the event spot inflation proves firmer than expected, we’d expect that will translate to higher 1y1y real yields, while real shorts ought to be somewhat better insulated from a moderation in inflation concerns. With a front-loaded hike cycle where terminal risks are skewed to the upside and market pricing now below our economists’ modal policy rate peak, we recommend shorting 1y1y TIPS real yields.”

• They issued this recommendation at -25bp, targeting a move to +15bp, with a stop at -50bp.