GBP Swaps: Gilts bear-flatten as BOE rings bell for second round

Chart numbers 14 Jun 2022
Gilts bear-flattened today as the BOE Governor warned about the second round of the fight against inflation and DMO sold a slug of short gilts.

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  • Gilts bear-flatten as BOE rings bell for second round 

  • Look for GBP 2y outperformance versus EUR: NatWest

  • New issues: Royal London, Co-Op Bank  


     Gilts bear-flatten as BOE rings bell for second round 

    The gilt curve bear-flattened and red SONIAs fell by as much as 9 ticks today against a backdrop of headlines suggesting that the UK is now in the grip of a ‘wage price spiral’, according to the BOE.


    That refers to Governor Andrew Bailey’s less graphic acknowledgement today of “second round effects” on wage and price setting following previous “external shocks” to food and energy costs. The result was a steady, low volume selloff in SONIA futures that matched similar moves in SOFRs and EURIBORs, with the gilt losing 25 ticks and 2s/10s flattening from around 3pm onwards to finish at -2.2bps (-3.4).          


    With the DMO selling £3.75bn in 4.125% 2027 gilts at 3.958% with bid to cover of 2.6, the front end of sterling had to digest more supply as well as the BOE comments. Although the auction bond outperformed on the day, the 3-5y area was the weakest part of the curve, with 5s/10s almost 4bps flatter at 15.2bps and 5y asset swaps 1.6bps cheaper at 25.2bps.


    At the long end, 10s/30s flattened gently to 43.2bps (-0.9) while the freshly minted 4% 2063 narrowed from +6.5bps versus the 2065 at launch yesterday to +5.5bps on the screens at the close. Outright, the new bond saw its yield rise by a modest 3bps.


    Finally, inflation found support from a two dollar surge in Brent futures and (perhaps) from Bailey’s warning about the dangers of inflation persistence. RPI swaps rose by 5-6bps at the front end and 1-2bps further out. CPI and RPI data are due next week, along with a £750m auction of the IL 2051.  


    Look for GBP 2y outperformance versus EUR: NatWest

    While much of the cross-market research on the merits of gilts versus Bunds has focused on the 10y area of the curve (back at 150bps and 4bps wider again today), analysts at NatWest suggest similar trades may be better expressed shorter on the curve and via options:


      “Buying front end UK is seen as strongly consensus, however and that may be right - valuations look appealing. We expect the trade to be validated by BoE decisions and weaker paying in 2y GBP, however, because mortgage origination is weak and curve inversion makes 2y fixes look unattractive. What’s more, greater take-up of short-term fixed-rate savings products will likely reduce bank paying in this area.”


      “To express the UK outperformance trade with less exposure to positioning in the near term and taking advantage of high GBP vol (and receiver skew) compared to euro, we like buying receiver spreads in GBP against selling receiver spreads in euro.  The basic version would be 40bp-wide in GBP funded by 50-wide in euro. This risks a 10bp loss in a big rally across currencies, but the full 50bp loss on the euro spread is only realized in a rally to 2.5% in 2y.”


      “A more bullish version, which we prefer, is (i) Buy 50-wide receiver spread on 6m2y GBP, (ii) Sell 50-wide receiver spread on 6m2y EUR, 20bp out of the money, (iii) sell 25bp-wide GBP 35bp out of the money.”


    New issues: Royal London, Co-Op Bank  

    • Royal London today priced a £350m perp NC10.5 RT1 CoCo sub (Baa3/BBB) to give 10.125%. Via BNPP (B&D), BofA and HSBC.


    • Co-Operative Bank sold a £200m 5y NC4 Green bond 9.5% due May 2028 to give 550.7bps over gilts. Leads are DB, GS (B&D) and NatWest.