GBP Swaps: Futures lead sell-off; Rare linker; Remit talk

Somersault flip 12 Aug 2020
A busy second session in this most wild week saw futures lead a reversal of the risk-on move and Severn Trent pop up with a rare linker. Remit talk.

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  • Futures lead sell-off; 10s/30s flattens

  • RPI alignment with CPIH and corporate linkers: United Utilities

  • JPM: Budget tightening and steepening eyed

  • Citi: Short 5y ASWs on expected supply pressure

  • New issues: Severn Trent CPI-linked


Futures lead sell-off; 10s/30s flattens

A busy second session in what is already this most wild of weeks saw a partial reversal of the two-session risk-off rally as the gilt market not only unwound some squeezy trades, but also attempted to find a sensible position ahead of tomorrow’s Budget and gilt remit.


“The big picture is that gilts and Bunds were playing catch-up with the UST sell-off (that started last night),” said one active gilt market participant today. “But it was pretty hectic,” he added, noting that a lot of the attempted risk-hedging has been funneled through gilt futures, and that volumes approached 350k as they sold off by a point.   


Looking to tomorrow and the source said that the QT era of multiple moving parts in the gilt market might dilute reaction to the gilt remit, the outperformance of 30y gilts versus 10y and also versus Bunds suggests at least some focus on the expected drop in ultralong supply relative to short- and medium-maturity gilts tomorrow.  


As for the risk-off move, that saw the 2y gilt rally more in one session yesterday than it has since 1992, the source said “it does feel like it’s already over,” citing the lack of eye-catching headlines relating to contagion today.


Elsewhere, the DMO got this week’s issuance wrapped in time for tomorrow’s Budget via a £3bn sale of 3.25% 2033 gilts. The tap came at an average yield of 3.495% and during a session that for the most part was in stark contrast to the drama of the previous two shifts, the yield meandered in a 3.44% to 3.54% range before reaching the close at 3.51% +14bps on the day but still 30bps down from where it closed on Thursday.


The 2s/10s gilt curve ended the day unchanged at +2bps as both ended the day 14bps higher in yield than they were last night, while 10s/30s flattened 6bps. In swap spreads the 2y ASW closed -4bps at 41.2bps, 5y was +0.2bps at 40.9bps, 10y was -1.4bps at -1.8bps and 30y was +0.3bps at -54.8bps. In inflation, breakevens were mostly weaker despite the nominal selloff with 5y -3bps at 3.58%, 10y was +3bps at 3.67% and 30y was +1bp at 3.36%.


RPI alignment with CPIH and corporate linkers: United Utilities

Elsewhere, there was a veritable flood of utility-and-CPI-related news today with issuance from Severn Trent (see new issues section) and United Utilities Water today provided an update relating to the fallback provisions in its RPI bonds maturing from 2030 – after which, RPI will align with CPIH. Remember that CPIH inflation is currently running 4.6% below RPI on an annual basis.


Its amended EMTN programme now references a relevant reference gilt thereby “reducing the risk of the cessation of or a fundamental change to RPI resulting in redemption of any future Notes at their indexed par value.”

United Utilities added it had also begun discussions with “certain” holders of its outstanding RPI notes  with a view to modifying their fallback provisions relating to a cessation or fundamental change to RPI.  The company described the discussions with its bond investors as “very constructive”, but added that the outcome was “not conclusive.” Further discussions are planned.


JPM: Budget tightening and steepening eyed

Looking ahead to tomorrow, JPM offers an upbeat view of gilt sales and recommendations on ASWs and the curve. It says “consensus estimates for gilt sales next fiscal year (FY23/24) are at £232bn vs. our estimate of £210-220bn, which if realized may modestly widen swap spreads as a knee jerk reaction. However, we think the expected increase in the proportion of short end issuance to at least 40% of total gilt supply plus the longer-term fiscal forecasts in the budget next week that will likely show a worsening medium-term outlook for the public finances can put narrowing pressure on 5Y swap spreads.”


Therefore, it concludes, “we keep a medium-term narrowing bias on 5Y swap spreads and expect the 5s/10s swap spread curve to steepen.”


Citi: Short 5y ASWs on expected supply pressure

One last strategic look at the Budget from Citi offers up a succinct look at the gilt split, and a trading recommendation for post-Budget trading. Citi says:

  • We stick with a gilt remit forecast of £246bn, albeit tweak our workings (+£8bn to CGCNRx met by Treasury Bills). There is upside risk should the OBR not forecast as large an undershoot this year.

  • For the split, we assume Shorts 33%, Mediums 28%, Longs 23%, Linkers 10%, Unallocated 6%: The risk is even fewer Longs/Linkers given demand concerns. 

  • Trade wise, the remit size/split is a wildcard for near-term positions, but the OBR’s forecasts are likely to reiterate long-term issuance pressure, keeping us short 5y gilt ASW despite tentative signs of improving domestic demand for gilts.


New issues: Severn Trent CPI-linked

  • Severn Trent has priced a £100m, 21 Mar 2045, 2.155% CPI-linked unsecured bond via RBC and Santander. This linker, once a common occurrence, especially from UK utilities but now extremely rare, came at par. The last similar new inflation-linked deal that Total Derivatives can find was back in July 2021, a £50m 0.01% 2039 EMTN, was linked to CPIH and priced at 114.925 to give a -0.762% RY via Santander and MUFG.