GBP Swaps: Familiar end to week; More gilt-Bund

Week ending on familiar note

“People have been seizing on the Bank Holidays to have a slightly overdue extended break,” said one GBP swapper at a leading GEMM, as another four-day week approaches its close. This might come to an end with the following fortnight not containing one single Bank Holiday, before normal service resumes on May 29.

The slightly under-powered May market conditions in the City of London then seem to have created their own trading tropes over these last two-to-three weeks with thin volumes dominant (gilt futures have managed 123K today with 90 minutes of trading to go), and a tendency to just do what Bunds and USTs are doing, but do it worse.     

As has been discussed a few times here lately this includes gilt underperformance in sell-offs (see Citi’s view on burgeoning gilt-Bund spreads below), which has been the story yet again today, as 10y gilt yields are currently underperforming Bunds by 2.5bps and USTs by 3.25bps).

On a more positive note, volumes would have been even worse this week were it not for a mini-revival in GBP-denominated new issuance. Though in a risk-averse theme the more significant deals were very much short-dated, including a £1bn 1y FRN from RBC and a £1.25bn 3y from NAB.

There were though a £250m 5y from Vattenfall and a £500m 10y Tier 2 from Rothesay earlier in the week, and there is still a £500m 5y about to be priced by BFCM. The above swapper said that the front-loaded issuance was possibly behind a gentle tightening of 5y ASWs, but said “the volumes (of new issues) wouldn’t normally be enough to be the main mover for ASWs… it will be interesting to see if things liven up next week.”  

Late in the London session today, with the curve bear-steepening ahead of next week's syndication the 2y benchmark gilt yield was +5bps at 3.76%, 5y was also +5bps at 3.58%, 10y was +6bps at 3.76% and 30y was +6bps at 4.20%. In ASWs the 5y is unchanged at 27.2bps, 10y is -1bps at -11.5bps and 30y is -2.5bps at -57bps. Green SONIAs took back 3-4bps of yesterday's 13-24bps post-BOE, US-assisted rally.

Linker B/Es are little changed from 5y and 1y RPI is +7bps, with the curve moves flattening down to unchanged from 10y onwards.  

Citi: Is it time to short Bunds vs 10y gilts?

As noted here yesterday (GBP Swaps: SONIAs gain as Ill wind blows MPC’s words away) the 10y gilt/Bund spread is being keenly watched. Since hitting closing lows of 86bps or so in Feb, it has ballooned as gilts regularly underperform bonds issued by the UK’s European friends and partners, particularly during sell-offs. Yesterday it hit a new wide of 154bps before contracting to 147bps, but after further underperformance today, it is sitting pretty at 151bps.

Looking at the reason for the gilt underperformance, and at where it may reverse, Citigroup strategists said today that “recent gilt weakness is likely more related to the run of upside data surprises in the UK, in sharp contrast to the Euro Area (EA). This is driving front-end GBP cheapening not just vs the USD (where one clear driver is US regional banking concerns and the Fed explicitly putting a pause on the table for June) but also vs EUR. In short, the rapid widening in 10y gilt-Bunds (one of the sharpest moves in the last 10 years, excluding the LDI episode) is highly likely a front-end (data) story, not a supply one.”

It insists that “the widening in the 10y gilt-Bund spread does not look an overreaction, it is consistent with recent data trends. However, history tells us that the de-coupling in UK vs EA economic surprises is unlikely to persist, which would take away a key driver for further widening.”

“While we are biased for a tighter 10y gilt-Bund spread (and wrongly have been for some time in truth), the May BoE meeting did not produce a decisive (tightening) trigger. The near-term risk is that the next round of UK data shows further strength (in wages and service prices especially, although headline inflation could offer a downside surprise) and there may be even better entry levels to fade 10y gilt-Bunds in the weeks ahead.”

It notes that gilt underperformance extends across the curve, but insists that “it has been primarily driven by a run of upside economic surprises in the UK,” and warns not to “blame gilt x-market cheapening on supply (yet) Supply pressure has been widely put forward to explain gilt cheapening cross-market (e.g. the FT article of 5 May). We agree that the slow burn story of supply is a long-term drag on gilt performance but disagree that it has caused the recent cheapening. Observationally, this is not true.”

Also, concludes Citi, “while the gilt supply story is well known, the gilt demand story is less so (e.g. the FT story made no mention at all of domestic demand). The suggestion that supply has driven recent gilt cheapening completely ignores record domestic demand.”

New issues: BFCM

• BFCM is on the brink of pricing £500m 5y bonds at gilts +75bps via HSBC and NatWest (B&D).