J.P.Morgan Take Profit On TIPS Trade, Turn Neutral

J.P.Morgan note that they "expect inflation to lift over the coming years, and for the Fed to be successful in achieving an overshoot of its 2% PCE inflation goal in accordance with FAIT. Against this outlook, the recent underperformance of front-end TIPS has been notable. A few weeks ago we recommended shorts in 5-Year TIPS paired with a 19% long in Apr-22 TIPS, given that forward breakevens at the front-end were priced for inflation firmer than our forecasts even while the pace of rate hikes implied by nominal yields appeared somewhat benign. Since then, 1Yx4Y breakevens have narrowed sharply, pushing front-end real yields higher even as nominal yields declined and the implied pace of hikes has slowed further. In fact, front-end TIPS are no longer priced for any material inflation overshoot over a 2- to 5-Year horizon, and the 2Yx3Y/5Yx5Y inflation swap curve is near its steepest level since late January. Meanwhile, 5-Year breakevens appear nearly 30bp too low versus our fair value model, triple the standard error of the model and the largest dislocation in over a year. Thus, while we think front-end real yields are likely to be biased higher over the medium term, we take profits on this trade and turn neutral on TIPS for now. Last week's employment report and yesterday's JOLTS data provided further evidence of supply/demand imbalances in the labor market, and we don't expect the data to show a fading of these pressures, and thus more material progress toward the Fed's maximum employment goals, until late summer or early fall."