GBP Swaps: Rally; NatWest trade ideas for the BOE

BOE Threadneedle street Oct 2022
CS and FRC headlines helped global bond markets extend rallies today. NatWest looks at BOE trade ideas for these new market conditions.

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  • Gilts rally again on CS; Inflation hopes help

  • NatWest: Pay Mar MPC; Fade cuts on the curve; Close SONIA receivers


Gilts rally again on CS; Inflation hopes help

BOE/Ipsos survey data showing UK inflation expectations for the next 12 months dipping from 4.8% to 3.9% gave gilts a slight edge over their peers in trading so far today, although as has been the case for most of this week, USTs have very much laid out the path for gilts to follow.


At the time of writing the 10y gilt yield is down by 14bps at 3.28%, compared to a 16bps drop in 2y yields and a 12bps drop in 30y.


One senior trader at a leading GEMM said this afternoon that “the one thing that has made them different (to USTs or Bunds) this week is that the BOE has the least scrutiny of those three big central banks.”


“It has said that ‘if the hike cycle is over, then it’s over,’ whereas the others have sent more committed messaging regards rate hike intentions. So the BOE is under less pressure to act or to clarify its stance, which means gilts have just been able to go along for the ride and try to muddle through.”


This, he conceded, has largely meant following the UST market and that clearly remains the case going into the end of a week that will have some market participants waking up in cold sweats for a while to come.


To recap, the 10y gilt has traded in a 3.60% to 3.24% range this week, matching the 3.90% to 3.55% range of the previous week when the talk of contamination started to spread like wildfire. And the 2y gilt yield has rallied 60bps since last Thursday.


Big moves which have seen the rate landscape dug up and replanted just as there are signs that inflation may be ready to take even more significant steps backwards on both sides of the Atlantic. In other words ‘happy days!’ As long as contagion doesn’t flare up and destroy the entire global banking infrastructure as it threatened to in 2008.


Talking of which, a flurry of downbeat Credit Suisse headlines led to an early rally across bond markets accelerate during lunchtime in London, and they include news that some of its bonds are trading at distressed levels that suggest its mega-billion SNB bailout loan may not be sufficient, while at the same time Bloomberg reported that its Swiss arch-rival UBS is reluctant to take CS’s risks on board via a merger. For some reason.


Elsewhere in GBP fixed income, SONIA futures are up by 2 ticks in the front-end of the curve and by 12-13 ticks in the back end. Mid-curve contracts are up by 60 ticks on the week! Swap spreads today have so far widened at most points of the curve with 2y +1.1bps at 38.8bps, 5y is unch at 40.1bps, 30y is +1bp at -56.3bps, while 10y has pushed the other way and is -0.6bps at -4.7bps. Linker real yields are down largely in line with nominal yields, and breakevens are little changed apart from 1-3bps drops in the front end of the curve, against a backdrop of 20-30bps losses at the front of the euro inflation curve, and near double-digit losses for short TIPS.


While anything could happen over the weekend or indeed next week regarding banks, scheduled news is pretty lively too, with RPI on Weds (Bloomberg consensus is 13.2%yoy) and what will likely be a very interesting BOE MPC outcome the following day.


NatWest: Pay Mar MPC; Fade cuts on the curve; Close SONIA receivers

Noting that “a week is a long time in monetary policy,” the above-market dovishness of NatWest strategists about the BOE has nonetheless still proved not quite dovish enough events in for the market themselves.


NatWest said today that “Having spent much of the past month defending a more dovish-than-priced BoE view and recommending received front-end rates trades, we find ourselves facing markets which are now outflanked us on the dovish side of expectations.”


With only a ~50% chance of a 25bp hike in March being priced in, NatWest said that its judgement is that markets have shifted too far in a dovish direction. At these levels, it sees value in:


  • "Paying March MPC SONIA (50% odds of a hike are low, which has barely shifted following the ECB’s 50bp hike, despite pricing for later meeting dates increasing);


  • "Fading cuts with Aug23-Feb24 steepeners (given we think an earlier and lower peak will allow the BoE to keep rates on hold for longer, even in the face of sticky core inflation)


  • "Close receive Sep-23 SONIA, which we entered in late February when markets were pricing in a peak of 4.8%. Markets are now much more aligned with our long-held view of a 4.25% peak in rates."