GBP Swaps: Underperformance; Lloyds; Box view

Underperformance; RPI bear-steepening

Gilts’ early strength faded as the Fed decision approached with underperformance versus Treasuries – despite strong ADP jobs data – pushing the spread to 10y USTs out to 31bps (+7) today while the spread to 10y Bunds grew again to 144bps (+3).

GBP rates’ sluggish performance was pretty much across the curve with gilt yields 2-3bps higher and SONIA futures 3-4 ticks softer in the reds (versus a 9 tick gain for red SOFRs on bank jitters). Still, volume in the gilt future was only around 179K and swap volumes reported to the SDR were below average, both because of the looming Fed and ECB rate decisions, and perhaps perhaps because there was no obvious domestic data or BOE-speak to drive the price action.

The DMO did sell £4bn in 3.5% 2025 short gilts at 4.121% and demand was OK (bid to cover was an unspectacular 2.56). Having been deemed cheap before the auction, the bond outperformed on the curve in the wake of the sale.

With a slide in oil prices gathering pace – Brent futures fell by three dollars today after losing four dollars following weak US data and renewed pressure on smaller banks yesterday – inflation swaps were weakest at the front end with RPI 2y down 11bps at 3.76% versus an unchanged 3.31% in 30y. Linker real yields rose by another 5-8bps with the freshly-minted IL45 now around 0.74% versus 0.65% at last week's syndication (although the bond has tightened to around IL44 +3bps from +3.75bps).     

In the news, Lloyds Bank shares fell by 3.6% today after the bank reported higher-than-expected first quarter profit but warned of weaker net interest margins. The bank’s structural hedge (see also NatWest and Barclays) remained steady from end-2022 at £255bn with a duration of about 3.5y. The hedge generated £0.8bn of gross income for Lloyds in the first quarter, up from £0.6bn a year earlier as rates rose. The bank also confirmed that all assets in its £140.5bn cash and government bond liquid asset portfolio were hedged for interest rate risk.

5s/10s ASW flatteners: RBC

Asset swaps cheapened for most of the session before richening back into the close to leave 5y little-changed at 29.0bps (+0.1) and 10y steady at -8.8bps (unch).  Writing shortly before today’s auction results hit the screens, RBC recommended a tactical 5s/10s ASW box flattener (1Q27/4Q36s) setting a target of -67bps and a stop at -59bps. It gave the following rationale:

“Last week, 5y cash underperformed on the 5s10s ASW box, despite the supportive demand/supply dynamics for the 5y sector of the curve (related to the 1y+ gilt index extension flows into month-end).

 

“The reason behind this cheapening of short-end cash can be explained by the pricing-out of repo specialness in the sector between Monday to Thursday of last week…This has resulted in 5y ASW spreads trading back towards YTD tight levels, the 5s10s ASW box back to YTD highs and important technical levels going back to 2017 and the 5s10s cash curve trading back towards YTD flat levels.

 

“On Friday, we noticed that repo specialness in the short-end of the curve started to get priced back in – and think a continuation of this process seems the path of least resistance in the short term. In fact, we think the reason the 5s10s ASW box hasn’t already started flattening back aggressively (reversing the steepening seen last week on the pricing out of repo specialness) is due to the 3H25s auction today and the consistent concession on the curve seen going into these events.

 

“Our favourite structure is going long the 5y sector on the 5s10s ASW box due to (1) the 10y sector having the added catalyst for underperformance over the coming week into the 3Q33s tap next week and (2) wanting to hedge against any sharp front-end repricing risks in a busy week for macro events/data.”