The moderation in inflation during 2023 was substantial, with headline inflation falling from 7.9% in January to 4.66% in December, and core inflation from 8.45% to 5.09%. We expect disinflation to continue this year and forecast headline inflation should end the year at 3.5% and core inflation at 3.7% YoY.
Inflation expectations as measured by breakevens (BEI) have already adjusted to the downside at the short end of the curve due to the moderation in inflation last year, and currently stand at levels of close to 4.23%, on average, in the 2Y-5Y section. However, long-end breakevens have increased in the last few weeks. The 10Y BEI currently stands at 4.7% and the 20Y BEI at 4.9%, while both, on average, tend to be closer to 4.0%.
The nominal curves moved significantly downwards since 4Q23, in anticipation of less restrictive monetary policy. However, the recent adjustment in nominal and real curves has resulted in an upward shift in implied breakeven inflation, which, in our view, is not in line with the aforementioned inflation outlook. In our Asset Allocation published in November, we stated that we saw more value in the long end of the Udibono curve based on our inflation risk balance and considering the level of the curve at that time. While our preference for long-term Udibonos remains intact, the current BEI level offers more value in nominal rates vs. real in the belly and long end. Consequently, given we expect continued disinflation this year, we anticipate a further adjustment in the 10Y and 20Y tenors. Hence, we see value in taking long MBono positions against short Udibonos, notably in the 10Y node, where the carry cost is low (~2bp).