GBP Swaps: Gilts lag as curves bear-flatten; DMO meetings

Bear-flattening and gilt underperformance

Bear-flattening across the sterling, euro and dollar curves saw gilts fare worst with a double-digit selloff at the front of the curve helping to push 10y gilt yields back up to 4.06% (+7bps) while the spread to Bunds tested a fresh seven month wide of 160.5bps, almost 4bps wider on the day.

The move flattened 2s/10s back to 2.2bps (-3.2) while SONIAs fell by as much as 11 ticks in the reds to leave Jun23 MPC SONIA pricing 22bps of hikes and Sep23 MPC a cumulative 50bps, implying BOE Bank Rate back at 5% in Sep23 for the first time since Oct 2008.  

Drivers for the (global) price action were a little unclear, at least to Total Derivatives, with talks over the US debt ceiling continuing and largely unsurprising central bank speak from various Fed and ECB officials. In sterling, the BOE sold another £770m in short gilts from its portfolio with a cover ratio of 2.97. The market rallied following the results of the BOE sale but this followed a fake news headline. Gilts then sold off to finish at session lows, led by the very front end of the curve.

Gilts 10s/30s flattened by 3bps to 38.8bps and the long end generally outperformed with the curve ending at the day’s flats.

Against swaps, most of the curve was narrowly mixed as the front end cheapened a touch to 23.1bps (-0.8) in 5y but 30y asset swaps edged up to -60.3bps (+0.4). SEB priced a 3y sterling deal and BP came in 15y, while Lloyds travelled in the opposite direction with a EUR 4y, NatWest printed a CHF 5y and WPP priced a EUR 7y.

Heading into this afternoon’s DMO supply meetings (see below) linker real yields rose by 3-7bps with the 30y now back above 1% and nudging 1.08%, its highest since the LDI crisis.  Breakevens widened as duration sold off and finished 1-2bps higher .  

Lower inflation, more linker supply: NatWest

NatWest looks ahead to a couple of this week’s key domestic events.

First, the bank reckons that a sharp fall in CPI to 8.0% in April from 10.1% should give the BoE some “breathing room”, particularly following hints of “cooling” labour demand and more labour supply in the data last week. NatWest continues:

“BOE speak suggests that the onus is on the data to prove that further tightening is required, and we don’t expect that evidence to materialise. Markets are overpricing the BoE’s reaction function.”

Second, NatWest looks at gilt supply and the recent fall in gilts. It finds that the selloff of the last 10 days has left 10y gilt yields “tracking well” for  its 4.3% target, after testing 4.09% at Friday’s high point. The bank explains:

“The supply-demand imbalance continues to weigh and dispels the myth that supply doesn’t matter for yields. Demand from the usual sectors remains limited and may not return until we reach higher yield levels or before markets have more confidence that inflation is coming off convincingly.  QT is set to continue, even if the Bank cuts rates, adding to supply risks.

 

“Although gilts look ‘cheap’, certainly on a cross-market basis, overseas investors are unlikely to feel compensated for the supply risks (and likely some hangover of political risks from last year too) while gilts still look this expensive on a hedged yield basis.

 

“LDI could be quicker to return, in theory. There is now more clarity on the regulatory  backdrop and the aggregate funding position published by the Pension Protection Fund suggests that some de-risking demand should materialise. But with little confidence (yet) that inflation is coming down meaningfully, an improved growth outlook and a well telegraphed heavy supply schedule, there appears to be little first mover advantage in resuming buying activity anytime soon.”

Meanwhile DMO meets end-investors and GEMMs today to discuss issuance in the July to September quarter, with the Minutes of the meeting due on Tuesday morning.

Two syndications are planned: one in the first half of Jul 2023, for a new or existing index-linked gilt; and the other in the first half of Sep 2023 for a long conventional gilt. Looking at the latter NatWest writes that, “opting to front-load its major supply events against a backdrop of very little demand from the natural buyers of long-end linkers feels like a slightly odd decision” by the DMO.  

The inflation market will also get three linker auctions in the quarter compared with four long gilt auctions.

New issues: BP, SEB, HICL  

• BP Capital Markets today priced a £400m 15y 5.773% bond due May 2038 to give gilts +140bps. Leads are Lloyds (B&D), NatWest and Santander. Books above £1bn.

   

• SEB sold a £350m 3y 5.595% bond due May 2026 to give gilts +155bps. Leads are HSBC (B&D), Nomura, RBC and SEB.

   

• HICL Infrastructure PLC sold a private placement loan note split £100m due May 2033 and £50m due May 2035 with a weighted average interest rate of 5.75%, after hedging. The notes were bought by PIC, Canada Life and Sun Life for £50m each.