GBP Swaps: Gilts outperform again; Easing debate looms

Gilts outperform again despite NFP surprise

The gilt market was able to enjoy a quiet bask in its new dovish post-MPC environment today, despite a 6bps reversal in 10y gilt yields – after a 30bps rally yesterday amid hefty re-pricing and short-covering flows. The 10y gilt still managed to outperform Bunds by 6bps and USTs by 7bps at the end of play, and the end of a mood-setting week.

While strategists generally see the next step by the MPC to be one last 25bps (probably) or 50bps (less likely) hike in March, among traders the range of expectations seems anchored between zero and 25bps.

The activity today versus yesterday were like night and day, with the heavy, insistent pan-curve buying either side of the MPC’s lunchtime announcement yesterday being replaced by a lower volume (albeit decent for a Friday with 200K of gilt futures changing hands) and calmer session.

The main excitement was a whopping overshoot of US NFP expectations, with a payrolls headline of +517K dwarfing the forecast +188K for January taking gilts from little changed to +4bps in no time, before they traded slightly softly as they meandered into the close.

Gilt curve steepening continues to cement itself on the long end irrespective of price directionality, and featured again today as 10s/30s closed about 2bps steeper at 54bps, having drifted down from the 55.7bps morning high. The 10y yield was +6bps at 3.06% at the close while the 2s/10s curve steepened 2bps.

Next week starts off with mainly second-tier data in the UK, and the week as a whole doesn’t have the scheduled potential for drama that this one always had. But with house prices trying to defy recent a sharp contraction in mortgage lending, the RICS survey will perhaps be of more interest than normal.

SONIAs rose by a further 0.5-2.5bps in the whites and reds with no sign of post-MPC second thoughts, with BOE Chief Economist Huw Pill sticking to the party line in an interview today. Green SONIAs fell by 0.5-3bps as the forward curve steepened.

In swap spreads the continuing outperformance of the 5y sector (5y yields rose just a couple of bps today) helped the 5y ASW widen 1.2bps to 48.9bps as it continues to settle in a range last seen just before the Truss interregnum, while the 2y had other ideas, plunging 7.5bps to 59.7bps, where it is testing tight levels not seen since April 2022. The 10y and 30y ASWs were both a little less than 1bp wider on the day.

In linkerland, the recently tamed 1y RPI swap pushed a mere 7bps wider while 30y was +1bp in ongoing normalized trading conditions that must leave some linker/RPI peddlers wondering if last Autumn was, like Alice’s Adventures in Wonderland, just a strange dream. Real yields backed up by 5-6bps at the long end, tracking nominals.

NatWest: Hiking pricing right; Easing pricing wrong

Reflecting on yesterday’s perceived dovish hike by the MPC, strategists at NatWest said they agreed with the market’s pricing of one more 25bps hike in this cycle, but doesn’t buy into the idea that rate cuts will come before the year is out.

NatWest said that “we do not push back against market pricing of peak rates… Markets look for another ~23bp of tightening by March, and an additional ~13bp thereafter. We see peak rates at 4.25% (i.e. 25bp higher than here), and think risks are skewed to the upside; another 50bp hike in March is more likely than no hike, we think. This is now fairly reflected in the strip.”

“We would however pushback against market pricing of cuts before end-2023. The market is now looking for ~35bp of cuts by Dec-23, which feels aggressive, especially with a lower peak in Bank Rate. It is less about pushing back on eventual rate cuts, but more the timing of these cuts. With still sticky core inflation and central banks that are very wary of second round effects, the hurdle to easing in this cycle feels higher than in previous cycles. The market has a full 25bp cut priced in from the peak in August to the November meeting (i.e. just three months from peak to first cut) which would considerably faster than in previous cycles.”

That, it says, just ain’t going to happen.

Looking a little further along the curve, where 10s/30s has been busily steepening for a little while now, NatWest says that “Some degree of hawkish re-pricing at the front-end should weigh on longer-dated rates, with the curve out to 10y currently moving in lock-step with shorter yields. Beyond that, however we continue to think that the supply-demand imbalance that will start to emerge in the next fiscal year will weigh heavily on longer-rates in 2023. Whilst we note some downside risks to headline supply numbers the funding required via gilts is still going to increase significantly and outpace demand.”

New issues: Northumberland Water

• Northumberland Water (Baa1/BBB) has priced an 8-year, £350m, 4.5% bond at gilts +145bps via Lloyds (B&D) and NatWest. Books above £975m.