GBP Swaps: Trusst issues; 5y ASWs collapse; 10y CTD confusion

Emergency Case
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GBP hit post-1985 lows and gilt yields multi-year highs as Truss-Kwarteng economics arrived. The 5y gilt yield rose as much as 60bps on a crazy day.

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  • Surplus of glits, shortage of Trusst?

  • Traders: 5y ASW collapse and 10y CTD confusion

  • RBC: If you think this year’s gilt supply is big…

     

    Surplus of glits, shortage of Trusst?

    The Great British Pound fell to its lowest valuation versus the USD since1985 and gilts staged a massive bear-flattening as the latest UK Chancellor made his mark with a tax-cutting non-Budget that promises an extra £60bn or so of gilt borrowing plus a slug of £10bn extra T-Bills over the next six months. The government’s attempt at reincarnation in a go-for-growth approach is clearly making the fixed income market nervous about the bust potential of it’s bold ‘boom-or-bust’ strategy for the economy.

     

    GBP is now valued at $1.0975 despite yesterday’s 50bps rate hike, which is 20% down from its $1.32 level back in the salad days of Spring, a mere six months ago. The FTSE-100 is down more than 2% today, despite confirmation of a cut in corporation tax.

     

    And in one of the eye-watering moves that have characterized 2022, the 5y gilt yield has surged 44bps (to 3.98%) having earlier risen 56bps to 4.12%, as the market processes plans for a front-end heavy boom in gilt issuance to help the UK get through what its government clearly wishes to be a short-term era of investing its way out of trouble.

     

    Chancellor Kwasi Kwarteng said this morning that his government will introduce tax cuts costing around £35bn to help struggling areas of the UK economy such as property investors, high income taxpayers and profitable corporations. Gilt sales are now projected to hit nearly £194bn for the year, with the front-end bearing the brunt.

     

    Currently the GBP gilt curve has bear-flattened 15bps on a 5s/10s basis and 20bps on a 5s/30s as the market sees inflation, BOE rate hikes,  QT and rising gilt issuance stretching out into the medium term. Swap spreads are -12bps in 5y, -0.5bp in 10y and -2.8bps in 30y.

     

    SONIA meanwhile has sold off by up to 56 ticks in the Jun24 contract with BOE rates now seen peaking at around 5.50% in Dec23. As one (admittedly EUR not GBP) swapper said this morning: "This is a big move in SONIA. It is basically a loss of confidence in the UK. In Truss we don't trust.” 

     

    Traders eye CTD confusion as 10y ASWs outperform

    Not all traders are as pessimistic. Back on Airstrip One, one long-suffering gilt trader noted that “if the Ukraine situation can find a decent resolution within six months (lowering energy costs) things could still go very right (for Truss and Kwarteng).” Indeed, Brent is almost $5 lower.

     

    But for today there were more pressing issues. The borrow-and-spend announcement saw time itself head backwards to places not familiar to all market participants. The above trader noted that “we are hitting levels in gilt yields we haven’t seen in decades. The 5y gilt yield above 4% hasn’t been seen since 2008 for example. So nobody is sure where the ceiling is.”

     

    Rate hike expectations reflect this sense of extended upside for rates. The above trader said that the market (as of mid-afternoon today) is fully pricing 100bps of hike in November, followed by 25bps in Dec, 70bps in Feb and a terminal rate of 5.5% in calendar H2 next year. Strategists at NatWest said today that they now see 10y gilt yields hitting 4.5% in the weeks to come, accompanied by supply driven 10s/30s bear-steepening and 30y ASW underperformance.

     

    Meanwhile, the above swapper said that the most ostentatious reactions to the maxi-Budget today were the unprecedented move in 5y gilt yields and a related 10bp surge in the 2s5s10s ASW fly which came as a function of 10y ASWs holding firm as 5y ASWs collapsed.

     

    Looking at the 5y gilt first, the swapper said that “the 5y sector has been the most over-subscribed part of the curve and the most special on repo. People literally can’t get enough 5y (and 3y to 5y) gilts which has sustained the ASW and set it up for collapse today.”

     

    In 10y, the trader said, “the ASW has been resilient though it is going better offered as I speak (about 2pm, when it was +2.5bps at zero). That’s because its been trading versus futures during a CTD change (from the 2032 to the 2035 gilt) and that’s confused people.”

     

    He said “the 10y outperformance looks wrong but that’s likely down to people covering their CTD changes in gilts, while the brokers are behind the curve on this and quoting the old CTD as people focus on Delta One and first order trades, and are putting 10y ASWs out of whack because people are wary of trading the gilt future because they (brokers especially) haven’t adjusted their duration hedges (to reflect the emergence of the 2035 as CTD).”

     

    But these are just relatively micro aspects of an absolutely crazy day of macro trading. One topic of strong interest to the nominal gilt traders is QT. The MPC surprised some yesterday by confirming its plan to plough ahead with £80bn of gilt sales, something that seems a tad counter-intuitive in a market soon to be carefully flooded with gilts by the DMO.

     

    But the MPC decision was pointedly made on the available information and with no speculation allowed regarding today’s events. One swapper said this afternoon that there is a simple and powerful argument for a QT re-think by the MPC. “When the BOE sells gilts they realise government losses (on said gilts) which only serves to make the deficit higher and increase the need to sell yet more new gilts.”

     

    Food for thought. Similarly, the BOE's need to sell gilts might even be fuelled by the energy cap. “If consumers feel more comfortable with capped energy prices then they might just splurge more on imported goods, which will impact the balance of payments and debt,” said the trader.

     

    Today was a big one for the nominal gilt market, while the inflation market took a back seat but was still fairly lively. One linker trader said this afternoon that “real yields have been less volatile (than nominals) because the market has already absorbed some of the inflationary impact (of Kwarteng’s mini-Budget)." So breakevens are up quite significantly, by about 7bps in the 10y sector, and by about 2bps in 30y.

     

    But, he added, “real yields and B/Es are very volatile because everyone is focusing on their core positions (which for a lot of the Street means nominal gilts, rather than inflation). 30y real yields are back up at +40bps 

      

    RBC: If you think this year’s gilt supply is big…

    If you like gilt supply, then RBC said today that next year will be even more fun than this. In a note put out after the Chancellor’s statement, RBC said there are “two reasons why the curve is flattening so much.” They are:

     

    • "Huge tax cuts means the Bank will have to tighten more so short rates are up . And as we pointed out the other day, even before this move 1y1y was at levels which, last time they were there, saw 10s/30s gilt curve inverted."

       

    • "The increase in gilt issuance is skewed to short end : £31.2bn increase in shorts vs £8.4bn increase in longs."

     

    RBC added, “the Treasury have published their 'scorecard' costing today's announcements. The tax announcements today aren't the main impact on this year's remit - that's the energy package. Today's announcements are costed at £4bn. But the big impact comes from next year on. In 2023/24 the tax measures cost £26bn rising to £45bn by 2026-27.”

     

    Or, in layperson’s words, RBC said “next year’s gilt issuance, along with QT will be huge – one of the key reasons gilts are so weak.”