BofA Global Research-US Rates Viewpoint TIPS in ‘23 Rooting for the anti-hero-99299448.pdf

Trading ideas and investment strategies discussed herein may give rise to significant risk and are not suitable for all investors. Investors should have experience in relevant markets and the financial resources to absorb any losses arising from applying these ideas or strategies. BofA Securities does and seeks to do business with issuers covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 6 to 7. Analyst Certification on page 5. 12489807 US Rates Viewpoint TIPS in ‘23: Rooting for the anti-hero In 2023 we think it will be time to move into long real yield positions. While the timing of the real yield rally will be conditional on concrete signs of an economic slowdown, our forecasts reflect a notable decline in real yields over the course of the year. We think the best way to express this view is to be long 30y TIPS. ‘23 Forecasts: conviction in the real yield rally We expect the 2s10s breakeven curve to remain modestly inverted and see more potential for stickier inflation vs what the market is pricing. Near-term inflation uncertainty should keep front-end breakevens elevated while back-end breakevens should be more anchored. We see financial conditions tightening further in the months ahead, which should generally limit the extent of a breakeven rally. One risk to higher inflation term premium is a Fed pivot on an increase in unemployment while inflation remains elevated. The October CPI print reflected cooling goods inflation which we expect to continue putting downward pressure on core inflation the months ahead. Greater confidence in a moderation in goods inflation reduces the risk of a Fed pivot before the job on inflation is done. However, risks around inflation remaining stickier for longer even as the economy cools lead us to favor the long TIPS expression. Our nominal rates forecasts are well below forwards by the end of 2023, largely stemming from expectations for a sharp decline in real rates. We expect 10y real yields around 85bps by the end of ’23 which is about 70bps below current levels and 65bps below forwards. While the near term risk is that market pricing for a higher terminal rate drives real yields higher across the curve, we think a higher terminal would also need to accompany higher inflation vs what is priced. 30y TIPS: carry today, yield compression tomorrow… We like owning 30y TIPS which we believe will offer higher carry than what is priced near term and has the potential to rally significantly on an inflection point in the data. Market pricing for inflation over the next year on a headline and core level is below our US Economists’ estimates. In general we believe that risks skew even above these forecasts. This translates to higher carry ove