GBP Swaps: Boring, boring sterling; PIC on buyouts, LDI; Banks on BOE

• Boring, boring sterling riding out the storm

• PIC on the buyout market and the LDI crisis

• MPC: One and done, or none then one?

Boring, boring sterling riding out the storm

Another quiet day in global fixed income markets saw 10y gilt yields trade in a suffocating 19bps range to finish near the highs, while the 2y sector managed a mere 16bps bottom-to-top move as the market calmly digested the news related to recent activities in Zurich.

In fairness, traders today were complimentary about the relative maturity with which the GBP fixed income market has dealt with the 2020s latest Global Crisis, amid – rightly or wrongly -- hopes that the worst excesses of this latest contagion panic might be behind us.

On a day made busier by the need for GEMMs to pack their pencil cases early, ready to dash off to discuss quarterly gilt supply with the DMO straight after work, one long-suffering GBP fixed income trader said that “conditions have been very challenging and people are trying to stick with easy trades where they can.”

“We are happy to hold (gilts), they trade slightly heavy at the moment and ASWs are reluctant to rally, both of which are consistent with the heavy supply calendars that stretch ahead. So because of that the gilt market has uncharacteristically had a quiet time of it in terms of volatility on a cross market basis,” he added.

Anyone who can remember the bolt of lightening that was the Truss Crisis will be confused by this. But for this latest SVB-CS Crisis (starting March 8), 2y gilt yields have traded in a 78bps range, while remarkably Schatz yields have covered ground totalling 123bps, and USTs have moved by 145bps top-to-bottom.

That’s a pretty massive difference. And leaves the front end in an interesting position, according to the above GEMM trading veteran. “Not only has GBP had a quiet time of things in terms of vol, it is only now starting to price in cuts. If you assume no further hike – which probably isn’t the majority view – then there are only 50bps of cuts priced in by the end of 2024.”

“The USD market,” he continued, “is pricing in 50bps by the end of this year.” In a related way, he added, “people have shorted cable (shorted GBP versus USD in FX) in a historically typical risk off move, and have lost loads of money.” GBP has risen 5c versus the USD since Mar 8.

When the dust settles on this month’s crisis, said the trader, there will be a lot for people to look at in terms of cross-market front-ends. Even more so presumably, in the unlikely event that the Fed hikes 25bps this week and the MPC remains on hold.       

At 4:15pm the closing levels l,ooked deceptively pacific. The 2y benchmark gilt was -2bps at 3.20%, 10y was +2bps at 3.30% and 30y was up 7bps at 3.82%.

SONIA futures were +4 ticks in the front end steepening up to plus +9 ticks in the reds. ASWs managed a decent 8.7bps plunge in the 2y, to 28.7bps, 5y was -2.1bps at 36.9bps, 10y was -1.9bps at -7.7bps and the 30y was -1.4bps at -59.8bps. In inflation RPI swaps were a fairly lively -15bps in the 1y, -5bps in 2y and then steepened up to +5bps in 30y.

PIC on the buyout market and the LDI crisis

Pension Insurance Corporation (PIC) released its 2022 Annual Report (link) today and the insurer repeated its bullish outlook for the buy-in and buyout market over the next few years, seeing potential for “over £200bn” of demand over the next three years, rising from around £28bn in transactions in 2022, to around £60bn in 2023 and £80bn in 2024.

At the end of 2022, PIC had £41bn in financial investments backing £33bn in pension liabilities, with the financial assets including 32% (£13.1bn) government debt and 36.9% (£15.1bn) corporate debt, of which around 37.7% of the latter was denominated in USD and swapped back to GBP.

On a smaller scale, PIC also had £1bn in Equity Release Mortgages, which it describes as another good match for its long-term liabilities, and a helpful diversifier.

As part of its hedging, PIC had derivative assets worth £22.5bn at December 31 2022 versus derivative liabilities of £25.4bn. Assets included £18.5bn in IRS and £3.3bn in inflation swaps, while liabilities were divided between £19.3bn in IRS, £2.4bn in inflation swaps and £3.3bn in currency swaps (PIC aims to remove all its FX risk through cross-currency hedging).  

As for the LDI crisis, PIC said today its operational capabilities stood the firm in “very good stead” during the crisis.

Although it doesn’t invest in the LDI funds which were at the heart of the turmoil – a product used mostly by DB schemes – PIC was required to post additional collateral. By end 2022, by which time market conditions in the swap markets had improved, PIC had pledged assets of £9.4bn (up from £4.2bn at end-2021) and received £5.0bn (versus £1.9bn at end-2021) in debt securities and cash.

It explained:

“The Group’s risk policies define a minimum proportion of its assets to be held in highly liquid cash and gilts, which can be readily converted to cash or used as collateral against movements in its derivative contracts. We monitor our liquidity position by reviewing Liquidity Coverage Ratio over various timeframes, and Medium-Term Cash Coverage Ratio on a weekly basis, and more frequently if market conditions warrant it, to ensure that we have sufficient headroom in the level of liquidity we hold above Board risk appetite. Stress testing is also conducted to ensure that there are sufficient liquid assets at all times to meet potential demands from derivative movements under extreme scenarios.”

Still, PIC plans a “fuller” review of its liquidity framework in 2023.

MPC: One and done, or none then one?

Friday and today found central bank strategists busily finalizing their forecasts for this week’s closely scrutinized MPC meeting. The range of genuine possibilities appears to be no change or 25bps. The majority preference is for 25bps, which is reflected in market pricing today as well, in which case consensus is also that it will be the last hike of this cycle. Alternatively, some strategists, including those at Barclays, thinks a ‘no-change’ vote followed by messaging giving the option for one more hike when the dust has settled on SVB, CS et al. Whatever the BOE does though strategists say the messaging will be as important as the headline decision. Markets are pricing close to a 50% chance of +25bps versus no change.

• BNP Paribas: "We continue to expect another 25bp hike at the Bank of England’s Monetary Policy Committee on 23 March, as underlying inflation remains uncomfortably high. However, tighter financial conditions following the SVB collapse make us more confident that this will be the last hike of the cycle, while also suggesting an elevated risk that the terminal rate has already been reached. Our central case is that the MPC will not change its guidance – already vague, with no implicit bias – but we see risks of a dovish shift to emphasise concern about over-tightening. Echoing the ECB, the MPC is likely to focus on its inflation mandate and point to the Financial Policy Committee standing ready to take macro-prudential action, should it be required."

   

• NatWest: "We expect the BoE to deliver one final 25bp hike this week. Although this round of central bank meetings come against a backdrop of heightened uncertainty, we expect macroeconomic concerns to outweigh financial stability concerns for the BoE, as we discuss in more detail in our BoE preview. Market pricing of less than 50% chance of a hike next week at the time of writing looks too low, especially after the ECB’s 50bp hike on Thursday. We see value in paying Mar-23 SONIA ahead of next week’s meeting, and we close our received position in Sep-23 for a ~50bp profit. This will be the last hike in 2023, though. We have long been of the view that although rates may not rise as much as the market was expecting just a week ago, they also might not need to be cut as fast as the market thinks. An early peak of 4.25% in March, against a backdrop of sticky core inflation, should mean the BoE keeps rates on hold throughout 2023 and into early 2024. Re-initiate Aug-Feb steepeners, looking for the curve to re-invert as the market prices out chances of an early rate cut."

   

• Barclays:  "With data largely mixed relative to BOE expectations, we think ongoing market turmoil tilts the balance for the MPC to keep the Bank Rate at 4% in March (vs. our previous call for a 25bp hike). We think the Bank will keep the option to hike further should markets stabilise, maintaining a flexible, data-dependent approach."