Front end gains as inflation peak seen
Another day of mixed gilt performance versus Bunds in the run-up to this week’s deluge of central bank meetings arrived despite the announcement of higher-than-expected DFA issuance (Total Derivatives). The latter news helped to crush 30y Bunds but the 10y sector of the German curve still managed to match gilts heading into the FOMC decision. And while lower-than-expected UK inflation data drove double-digit gains at the front of the SONIA curve as rate hike expectations were pared back, the benefits for gilts petered out beyond about 7y as the BOE sold a chunky £3.8bn of stock at today’s unwind operation.
In the data, CPIH inflation printed 30bps below the Bloomberg market median at 9.3%, also down from versus 9.6%. CPI inflation slowed to 10.7% from 11.1%, and even runaway RPI decelerated to 14.0% from 14.2% - although the wedge still widened and RPI was the only major measure to print higher-than-consensus.
Inflation market reaction to the data was mildly negative at the front end with real yields 3-5bps higher and RPI swaps 6-7bps tighter. However, the long end was more resilient with 30y real yields down 6bps and 30y RPI up 7bps.
Meanwhile acceptances at the BOE’s largest operation to date were concentrated in the £1.7bn 3.25% 2044, the £350m IL 2047 and the £326m 0.875% 2046. However, gilts were sold across most of the list where bids were received.
Finally, asset swaps cheapened at the very front end as SONIAs rallied but the rest of the spread curve was more mixed with 5y at 62.7bps (+2.9), 10y at -2.6bps (-1.3) and 30y at -50.2bps (+5.0).
MPC expectations, the curve and APF sales: Banks
Nomura and NatWest are the only banks in the Bloomberg survey forecasting a 75bps BOE rate hike this week and thus JP Morgan stands firmly with the majority in expecting a 50bps move. Even with the FOMC yet to deliver, the CPI data has firmed up the market’s belief in 50bps with Dec22 MPC SONIA 3bps lower at 3.47%, implying a 54bps increase from the last SONIA fix of 2.93%. Further out the curve, MPC SONIA dates from Jun23 onwards are 10-13bps lower in the wake of the drop in the inflation rate the and the forward curve peaks at 4.58% for the August meeting.
Still, even banks like JP Morgan that expect a 50ps hike, still look for a split vote with "both hawkish and dovish dissents”. The bank continues:
- “We view current market pricing of an expected 4.6% BoE terminal rate as fair accounting for some uncertainty premia around the end of the BoE’s tightening cycle.”
Further out the curve JPM is “neutral” on duration and expects 10y yields to trade in a choppy range into Q1 23. However the 2s/5s/10s SONIA fly is “at its richest outright levels since September” and also looks “modestly” rich versus 5Y SONIA yields on a short-term regression basis. As for JP Morgan’s views on the long end:
- “10s/30s gilt curve looks too steep on an adjusted basis but we see little value in fading given the BoE still has around £12bn in nominal terms of 20Y+ conventional gilts to sell. We see risks of further 10s/30s gilt curve steepening given the dynamics into the BoE’s reverse enquiry windows”
Elsewhere, RBC suggests shifting 10s/30s steepeners to 10s/50s or 20s/50s, the latter on the view that the 15-20y sector could offer some shelter from the BOE+DMO long end issuance “storm”. Meanwhile the bank will be watching Friday’s BOE announcement for a decision on when/how the BOE will start to sell long gilts from its APF portfolio as well as from its emergency FSGP holdings, perhaps once the latter are fully unwound. That could come relatively soon given the significant increase in bids and acceptances at the BOE’s last few operations.