GBP Swaps: Gilts outperform led by 10y; ASW drivers

Dull British house 13 Nov 2020
10y gilts outperformed as issuance continued to weigh on the front of the asset swap curve. Elsewhere, RPI fell by double-digits at the front end.

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  • 10y leads gilts' outperformance; Inflation weak

  • The impact of issuance and mortgage hedging on spreads   

  • New issues: Almost £3bn priced


    10y leads gilt outperformance; Inflation weak

    Gilts’ straight-line rally today had pulled the future 180 ticks higher by the time the close approached, with volume up to 180K as more return from the new year break. The gains were echoed in Bunds following soft French inflation data but gilts outperformed led by the 10y area of the curve, where benchmark yields fell by 16bps to back below 3.50%.


    Soft UK mortgage data (see below) stoked concerns about a weakening housing market while PM Rishi Sunak’s set piece speech didn’t contain anything to scare the (bond) horses as he pledged to reduce inflation and cut the national debt.


    SONIAs rose by up to 9.5bps in the whites and 17bps in the reds, with MPC forwards now implying a peak for BOE Bank Rate of around 4.61% in August 2023, 111bps above current levels.        


    Along the gilt curve, 2s/10s bull-flattened from 12bps early doors down to 7.5bps at the close, 2bps lower on the day.  5s/10s came down to 1.2bps (-2.8bps) and 10s/30s steepened to 33.0bps (+2.7) as long gilts lagged in the rally.   


    Finally, inflation suffered from a triple whammy of a $3 fall in oil prices, a 10% drop in Dutch gas futures, strength in nominals and weakness in EUR inflation, with the latter down 20bps at the front end in the wake of the French CPI data. RPI 1y and 2y swaps both lost 16bps, while 30y RPI finished 8bps lower.   



    The impact of issuance and mortgage hedging on spreads   

    Today’s £2.2bn in swappable, 3y to 5y fixed rate issuance, plus Thursday’s £3.5bn 4.125% 2027 gilt auction, are both potential reasons for pressure on asset swaps at the front end of the curve and 5y cheapened by 2.3bps to 48.0bps, its first move below 50bps since the Kwarteng disaster-Budget in late September.      


    Similarly, with cross-market issuers prominent, cable basis continued to tighten today with 5y up to -19.125bps (+0.25) amid plenty of clips in 3y, 4y and 5y on the SDR (link).


    However, the tightening in asset swap spreads was much less than yesterday and 3y cable basis today widened a touch to -15.25bps (-0.375). RBC highlights that recent asset swap cheapened will “impact the arb dynamics for issuers looking at opportunities in the sterling market” and it now expects issuance to be centred around the 2025/2026 maturity in the near term since “the economics further out have worsened materially the past few weeks.”


    Reduced 5y issuance in future could provide support for asset swaps but RBC also mulls whether a softer housing market could weigh on spreads, as lenders reduce mortgage hedging.


    Data today showing a 20%mom drop in mortgage approvals to a lower-than-expected 46K in November, well below the five year average of 69K, underlines the downturn in the market over the last few months of 2022. RBC writes:


      “As substantial as the drop-off in mortgage approvals has certainly been, anecdotally the drop-off in mortgage hedging (eg mortgage lenders paying 5y swap to hedge the 5y fixed payments they receive from fixed rate mortgage borrowers) has been even more precipitous.  


      “Some of the hedging will be done when a new mortgage product is first launched, so the trend in mortgage approvals will tend to lag the trend in mortgage hedging.”


      “Lenders are also substantial providers of savings products and much of their hedging will be done internally (ie they need to receive fixed against savings products and pay fixed against mortgage products). Thus the paying flows that the market sees from mortgage lenders are the residual left over from any internal offsets. It follows that a given % reduction in mortgage lending can translate to a much larger % reduction in external hedging needs”


       “This drop-off in mortgage hedging flows will represent a major structural shift in a sector of the curve where the core building blocks of swap market flow have been mortgage-related paying vs issuer-related receiving.”


      New issues: Almost £3bn priced

        Barclays today priced a self-led £1bn 8y NC7 at gilts plus 280bps.


      • CoE Development Bank today priced a £500m 3y bond at gilts +82bps. Leads are BofA (B&D), NatWest and RBC. Books above £780m.


      • Asian Infrastructure Investment Bank (AIIB) today priced a £350m long 3y Sustainability bond at gilts +100bps. Leads are HSBC, Nomura and TorDom (B&D). Books above £740m.


      • TD Bank today priced a £350m 5y note at gilts +175bps via Lloyds, NatWest, Nomura (B&D), TorDom and UBS. Books above £450m.


      • Westpac today priced a £750m 5y Australian Covered FRN at SONIA plus 75bps through Barclays, HSBC, Lloyds, NatWest, RBC (B&D) and itself. Books above £860m.


      • Pacific Life GF II (Aa3/AA-) plans a GBP 5y benchmark FA-backed bond after meeting investors on Jan 4.  Leads are Barclays, DB and JPM.