GBP Swaps: 2022/23 ends with a whimper; BOE on LDI & HFs

Beneath a calm sea 30 Jan 2023
A year that had a lot of people roaring at one time or another saw the GBP fixed income market end it with a whimper.

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  • 2022/23 ends with a whimper

  • Hedge funds helped during the LDI crisis – but charged for it: BOE


    2022/23 ends with a whimper

    UK GDP continued to fend off recession risk with today’s headline showing a whopping 0.1% GDP of growth by the economy at the end of 2022, completely blowing away expectations of a 0.0% outcome. But meantime, one of the key pillars of the UK economy – the property market – had less good news, with a Nationwide monthly survey suggesting property prices have fallen 0.8% on the month and 3.1% in the last year, the biggest such drop since 2009.


    None of which made much of an impact on the GBP fixed income market, which this week has been driven by calendar factors, new issuance flows, a DMO long end supply pause and some standout hedge fund flows. That reportedly included paying of 2s/10s IRS yesterday that saw that part of the curve resist flattening in other markets, even as the long end of the gilt curve continued to flatten on the day.


    Having lived 2022/23 like the most vengeful of wolves, tormenting people with the unpredictability and the width of its mood swings, the GBP fixed income market has managed to end the year like the sweetest of lambs, barely moving at all day-on-day as if in the hope all that went before will be forgotten, and underperforming Bunds in the process.


    Even on what in the past has been an extremely busy day for the 10y-plus part of the nominal curve has been dull (gilt futures volumes were 215K), though this isn’t a total surprise. It once was that at around 4pm on the final day the 10s/30s gilt curve would flatten aggressively as pension funds and other long-end investors would pile in.


    In recent years, these expert professional investors have started to do this a few days before the final session of the year. Amazing thinking and a great innovation which, traders told Total Derivatives last night, which is largely why (though the BOE may have helped, see  Total Derivatives) 10s30s gilts has flattened from 50bps a week ago to 34.8bps today. And has managed that despite steepening 1.8bps during this final session of the week and year.   


    At the close today the SONIA futures curve was 1-4 ticks firmer in the reds and greens, 2y gilt yields were -1bps at 3.43%, 10y was -3bps at 3.49% and 30y was -1bps at 3.84%. In ASWs the 5y was -1.5bps at 35.4bps, 10y was unchanged at -9.5bps and 30y was +0.2bp at -58.8bps. The price timidity was also apparent in RPI where real yields rose 1bps in 30y while RPI swaps were +4-7bps at the front but -3-5bps at the long end.


    This fiscal year had a lot of grim, troubling and surreal elements to it, including Ukraine, Truss and at the very end, SVB. Hopefully 2023/24 can be defined by peace in the East, some UK economic recovery, no more micro-crises and a boom in chronically under-valued south London property prices. But in the short-term, with Easter looming, swappers this week expressed a broad interest in a few days off, and a couple of weeks of relative peace and quiet.


    Hedge funds helped during the LDI crisis – but charged for it: BOE

    After the FPC this week recommended a 250bps 30y real yield stress test for LDI funds (see here and here), the BOE today published some interesting research by its staff setting out in detail what went on during the Autumn 2022 gilt crisis.


    The paper uses transaction-level data for gilts, repo and swaps to analyse “market liquidity, investor behaviour and price dynamics” during the market disruptions in September and October 2022. It concludes that:


      “Firms in the LDI-pension-insurance (LDI-PI) sector who had larger repo and swap exposure before the crisis sold more gilts during the crisis (while hedge funds were compensated for providing liquidity to the LDI-PI sector). 


      "Transaction costs in bond markets quickly soared, particularly for smaller trades, for trades at smaller dealers and for trades of non-LDI-PI investors too. The aggregate dispersion of transaction prices more than doubled in a matter of days, and price dispersion across primary dealers remained significant throughout the crisis, suggestive of tightened constraints on the intermediary sector. 


      "While the episode started with the forced selling by the LDI-PI sector, our results point to large costs on other market segments as well, consistent with the contagious nature of illiquidity.”


    For more please see here