GBP Swaps: Bailey lifts front end; Long end weak

Price charts 25 Nov 2021
Dovish comments by the BOE Governor supported the front end today with SONIAs in the green In contrast the long end bear-steepened, led by real yields

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  • Bailey lifts front end, long end weak led by RY

  • JPM: Likes 10s/30s steepeners, wary of cheap ASW

  • New issues


    Bailey lifts front end, long end weak led by RY

    Gilts' steepening stood out against the (bear) flattening in Bunds and Treasuries today as the short end of the sterling curve benefited from dovish comments by BOE Governor Andrew Bailey ahead of the MPC meeting later this month, while mediums digested a 2038 auction and longs looked forward to more supply of the 2061 next week.


    Bailey told a conference that “some further increase in Bank Rate may turn out to be appropriate but nothing is decided”, with the economy “evolving much as we expected it to,” according to the Governor. SONIAs opened in negative territory before his remarks but jumped 12bps as the market digested the comments, before slipping from the highs through the afternoon alongside persistent weakness in SOFRs and EURIBORs today following stronger-than-expected ISM manufacturing prices paid data, and a rise in German inflation. 


    Today’s UK data was more mixed with soft Nationwide house price numbers (-0.5%mom/-1.1%yoy) and weaker mortgage lending (£2.5bn) partially offset by strong BRC Shop Price inflation (8.4%), higher consumer credit (£1.6bn)  and steady mortgage approvals (39.6K).  SONIAs finished off the highs but still 3-6bps stronger led by the Dec23 contract, with volumes above 90K for the front whites. 


    Moving out the curve, the DMO sold £2.5bn of the 2038 at 4.142% with bid to cover of 2.41. The bond rallied to 4.06% on the follow, helped by Bailey’s support for the front end,  before slipping back late in the session to test 4.15%, finishing at 4.13%.


    Still, ultra-longs performed even worse as the long end bear-steepened with 10s/30s bouncing off 30bps and rising back to 37bps (+6.0), while 30s/50s edged up to -30.3bps (+2.3) as 50y yields sold off by 9bps.    


    The asset swap curve steepened as Bailey rallied the front end with 5y spreads falling to 38.8bps (-2.0) while 10y were little-changed at -11.6bps and 30y spreads drifted down to -58.0bps (-0.8).


    Finally, inflation outerperformed nominals out to 10y with real yields lower and cash breakevens around 3bps wider. In contrast, long end real yields rose sharply into the close with the 30y RY up again to 0.79% (+8bps), its highest level since mid-October, while 30y breakevens fell by just a bp to 3.40%.  


    JPM: Likes 10s/30s steepeners, wary of cheap 5y ASW

    JP Morgan research this week updates on a couple of its gilt views. First, it likes 10s/30s steepeners:


      “The 10s/30s gilt curve looks 5bp too flat vs. the level of 1Yx1Y SONIA, 30Y yields and the 10s/30s UST curve. This is the largest relative flatness seen since the LDI deleveraging and we enter tactical 10s/30s gilt curve steepeners. This is more a tactical view on the relative flatness with an uncertain long end demand backdrop in the 30Y sector than a longer-term strategic view and the RV should provide some protection against a further sell-off in yields. Although we see potential for 10s/30s  curve to steepen more substantially over the medium term we think it is too early to  aggressively position for end of BoE hiking cycle trades.”


    Second, JPM finds 5y swap spreads cheap but is wary of fading the recent move:


      “Both 2Y and 5Y swap spreads are around 20bp too narrow on a relative basis vs. 1Yx1Y SONIA and rolling 3M GC – SONIA spreads. In fact, ignoring the period around the September/October deleveraging 5Y swap spreads are at their cheapest relative levels for the past two years.


      “(However) we are wary of fading current valuations. We revised down our gilt supply expectations for FY23/24 to £210-220bn but with an increase in the proportion of short gilts and hence we think there is limited widening potential for 5Y swap spreads over the coming weeks.


      “Although we think market consensus is shifting towards lower expectations for gilt issuance next fiscal year, we expect the OBR will revise down its longer-term growth forecasts which will result in higher long-term deficit and borrowing estimates.


      “It is not clear whether swap spreads will be driven more by short term downward issuance expectations for FY22/23 or by weaker longer term fiscal projections. The recent ongoing narrowing implies maybe the latter but is also likely reflecting a strong market consensus view that gilt issuance can be skewed towards a large proportion of short end gilt issuance in the FY22/23 issuance remit. Over the medium term we have a narrowing swap spreads bias and think 5Y swap spreads  have more room to narrow than 10Y.”


    New issues

    • The DMO today confirmed that the auction on March 8 will be for £2bn of the 0.5% 2061 conventional gilt.