GBP Swaps: Bear-flattening; Time to sell 10y ASW?

Bear-flattening in low volumes

Catch-up with Treasuries’ negative reaction to non-farm payrolls at the end of last week plus further losses for USTs ahead of CPI later this week added to the pressure on gilts today, which were unable to sustain a brief attempt to rise from opening lows. Gilts outperformed Bunds across the curve but the future still fell more than a point in low post-holiday volume of just under 140K.

At the front end, the announcement of Kroll Chief Economist Megan Greene (link) to replace the dovish Silvana Tenreyro on the MPC starting July 5th failed to lift SONIAs’ mood. The futures opened around 9 ticks lower in the reds and finished 14-17 ticks down, with only the whites achieving volumes above 20K. Ahead, BOE Governor Andrew Bailey speaks at the IMF meetings in Washington on Wednesday.

Gilts 2s/10s bear-flattened to 7.4bps (-2.2) while 10s/30s came back down to 33.8bps (-0.5). In inflation, the DMO is due to sell £900m of the IL39 tomorrow with the real yield curve bear-flattening along with nominals ahead of the supply on the back of a 14bps sell off in short linkers today, while the IL39 backed up by around 11.5bps on real yield, roughly in line with the rest of the curve. Cash breakevens tightened by around a bp in the 15-20y sector but widened 2-3bps at the long end.

Sell 10y against 30y asset swaps: Barclays

Gilt asset swap spreads cheapened at the front end again with the 5y at 33.8bps (-1.6) but the 10y spread remained in its recent range at around -10.0bps (-0.7).  Still, strategists at Barclays make a case for selling 10y asset swaps against 30y citing the richness of 10y spreads given the “very heavy 10-25y supply schedule in Q2 23.” Their rationale is that:

• “Supply falls heavily on the medium and 15-30y part of the long end, as the supply of gilts rotates to mirror the easing of structural demand for long duration from liability hedgers…Of the £61bn total (cash) supply over the quarter, £44bn will be in sub-15y maturities, with £18bn in 7-15y sector alone.”

   

• “(Even so) the belly of the asset swap curve remains notably rich in forward space…(And) there should be reconnection between deficit expectations and the level of 10y spreads as we exit the QE era.”

   

• “In contrast…long-dated conventional supply, especially in the ultra-long end, is very low…(30y spreads) stand as cheap as they were at the time of the LDI crisis. Structural demand from end-users is in swap form rather than for gilts. However, in the transition phase towards a buy-in or buyout, pension schemes tend to want to buy gilts.”

   

• “(LDI) funds are probably well positioned and comfortable in terms of liquidity and ready to add to duration should it be required in order to facilitate liability hedging.”

   

• “During the last bout of market turbulence 10y gilt asset swaps failed to keep pace with the widening in 10y Bund asset swaps in the generalised flight-to-quality move. This suggests that the short base in 10y gilt spreads is markedly smaller than the equivalent one in Bunds…

   

• “Key buyers of 10y (gilt) spreads have traditionally been domestic bank treasuries as part of their HQLA portfolios…(However) for sustainable demand to appear for the sector, we would need to see a significant cheapening in the outright level of 10y spreads to around OIS +15-20bp”

   

• “Longs in the gilt 10s/30s ASW box…helps to ease the negative carry from the outright short, but also benefits from a return of LDI-driven demand for the 30y…Entry level +55bps, with a initial target of +45bps and a stop at +65bp, the position carries slightly negatively (-3bp) over 3m.”