GBP Swaps: Dovish hike helps to bull-steepen

BOE MPC Bailey May 2022
A brace of dovish rate hikes helped gilts to forget yesterday's bad CPI and look instead to the possibility that today's could be the last.

Start a free trial to read this article

Join today to access all  Total Derivatives content and breaking news. Already a subscriber? Please Log In to continue reading.

Or contact our Sales Team to discuss subscription options.

Get in Touch
Blurred image of Total Derivatives article content


  • Dovish hike helps to bull-steepen

  • Sell 10s on the 2s/10s/30s gilt fly: NatWest


    Dovish hike helps to bull-steepen

    A brace of dovish rate hikes from the Fed and the BOE over the last 24 hours even with inflation still running far above target in both economies reminded both how much tightening has already occurred – just shy of 400bps by the BOE since it started to raise rates in late-2021 – and how uncertain central bankers are about the risk of financial instability. The minutes of the BOE meeting and an interview with Governor Andrew Bailey both tended to play down the significance of this week’s CPI beat and, after the BOE delivered the expected 25bps hike today, the sterling curve extended the bull-steepening that had began before the Bank's announcement as the market caught up with last night’s FOMC decision.


    Approaching the close, white SONIAs were near session highs and 6.5 ticks to 23 ticks firmer in the whites, rising to as much as 28 ticks stronger in the reds as the latter more than re-traced the losses seen after yesterday’s CPI print. Meanwhile European bank shares lost another 1% to 4%.  


    Short gilt yields fell 20bps in 2y and 16bps in 5y, steadily bull-steepening 2s/10s to 8.4bps (+11.4) and 5s/10s to 15.2bps (+6.9bps). Further out the curve, gilts failed to keep up with the rally in Bunds with the 10y area lagging by around 5bps, but 10s/30s gilts still rose to 47.2bps (+3.9) as the gilt future gained a point in slightly below-average volume of around 180K. Asset swaps mostly cheapened with the 10y tightening to -9.7bps (-1.2) albeit with still no sterling issuance on the screens.  


    In inflation, BOE dovishness was accompanied by a rise in gas futures and further strength at the very front end with RPI 1y up another 20bps to 3.99% after hitting 4.06% shortly before the close, while 2y ended near session highs at 4.01% (+10bps). The belly of RPI underperformed as real yields bull-steepened and 10y RPI fell by 6bps to 3.67%.   


    Sell 10s on the 2s/10s/30s gilt fly: NatWest

    The BOE’s policy guidance “was not altered in any material way” today reckon analysts at NatWest. Further rate hikes by the MPC remain  conditional on ‘evidence of more persistent (inflationary) pressures’ but there was no overt shift towards more neutral or symmetric guidance.


    Still, NatWest judges the overall tone of the March Minutes as “mildly dovish” given that MPC “does not seem remotely fazed by the overshoot in CPI" in February and, "more importantly, continues to reference evidence of easing wage inflation.”


    Hence NatWest sees 4.25% as the peak in Bank Rate even though core inflationary pressure means that the bias to rates remain tilted to the upside with the risk of another 25bps hike to 4.5% in May. NatWest continues:


      “Rates will not rise as much as the market is expecting in 2023. That said, we continue to think that early rate cuts are also unlikely. The hurdle to return to easing is higher than the market currently prices, and higher  than we’ve been used to in previous downturns. We would push back against both the  100% chance of a 25bp hike by August being priced, and then the 100% chance of a  25bp cut after that by February.


      “(For gilts) tomorrow’s QT calendar will  matter more than today’s meeting, which we expect to confirm a marginally faster pace of purchases than in previous quarters. Even a slightly faster pace of purchases, if occurring in isolation, would not necessarily weigh on yields significantly, though. It is the combination of BoE active sales and a heavy DMO supply outlook that we expect to gradually shift yields higher over the coming months.


      “We hold our target of 4.3% in 10y gilts by Q3 and expect 10s to underperform on the 2s/10s/30s fly. Front-ends are now over-pricing the BoE’s near-term reaction function, and natural buyers of gilts  may materialise more quickly and at lower yields at the back-end of the curve (i.e. from LDI) than at the front-end or the belly (i.e. from overseas investors or from bank  treasuries).”