GBP Swaps: ISM contrasts with UK woes but gilts outperform Bunds

Bank of england front Oct 2022
Core bond markets rallied gleefully after ISM data, and gilts again outperformed Bunds (just). NatWest asks if it's time to board the gilt bandwagon?

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  • ISM data contrasts with UK woes as gilts bear-flatten

  • NatWest: Is it time to buy into gilt outperformance?

  • New issues: TorDom, Close Brothers


ISM data contrasts with UK woes as gilts bear-flatten

Core bond markets rallied gleefully from session lows after weaker-than-expected US ISM Services data (50.3 in May versus forecast 52.4) sent 10y UST yields plunging 9bps. The 10y gilt yield failed to match that move but still dropped about 4bps to 4.17% before closing at 4.20%, up 5.5bps from Friday’s close, but 2.5bps below its intraday high as the curve bear-flattened.


For much of the session gilts were again comfortably outperforming Bunds before the ISM data saw a bigger bounce for Bunds and by the end of the session gilt yields were +5.5bps versus +7bps for Bunds.


Nonetheless, as one active market participant noted this afternoon “the 10y gilt Bund spread is now 184bps after peaking at 197bps. It’s worth noting that unusually it got up to 220bps in September and October last year, which confuses people who ask ‘are things as bad as they were in the Truss era?’”   


“Well politically they are a lot more stable but that doesn’t mean there’s no rate hike risk, core inflation (which for April rose to 6.8% from 6.2% in Mar) is refusing to go away and is at its highest since April 1992! So while gilts still appear cheap to Bunds the ability of that spread to tighten much more really depends on data showing the UK is shaking off this sticky inflation.”


On a hopeful note, after peaking at 8.2% in May 1991 core inflation ended 1992 at 2.3%, marking the start of almost 20 years of core CPI being kept below 4%, and mostly below 2%. 


The above market participant said that aside from recovering after a weak start, and bouncing on that ISM data this afternoon, it has been a pretty forgettable and low-volume  day in gilts, with the exception of the BOE’s APF gilt sale which was carried out about 20 minutes before that 3pm ISM number hit the screens.


The 2030-2042 £770m gilt sale received as strong 2.49 times bid/cover, focused on the 0.375% 2030 gilt which saw £305.9m of bids accepted, and the 4.75% 2030 and 4.25% 2032 gilts which both had £209.5m of bids welcomed by the BOE’s sales team.


Looking at the overall gilt sale operation the above gilt source said that “shorter bonds always do well, particularly the 2030’s maturities, because they are fairly scarce in the market. I’m not totally sure why it went so well beyond the recent cheapening of the market.”


Finally the source raised some eyebrows at MPC pricing, noting that earlier today the market was pricing in 96bps of hikes by December. He said that “most economists see 50bps as possible, or 75bps at a stretch. But 96bps seems overdone.”


Strategists at Morgan Stanley vehemently agreed with that view in research today that reiterated its expectations of a 4.75% peak, versus market pricing of 5.5%. MS said that “our economists’ forecasts both on the inflation and monetary policy front are more dovish than implied market pricing. Money market valuations should then factor into expectations for rate cuts, leading to steeper curves.”


On the curve today at the 4:15pm close, 2s/10s gilts was 3.2bps flatter at -22.8bps and 10s/30s was 2.2bps flatter at +30.1bps. SONIA futures meanwhile never shook off their early weakness, closing unchanged at the front end but selling off by 14 ticks in the reds and greens.   


Elsewhere, in ASWs the 2y ended the day -0.5bps at 32.4bps, 10y was +1.2bps at -11.1bps and 30y was +1.6bps at -57.7bps. RPI swaps rallied 6-9bps across the curve, with the front end buoyed by overnight news of a reduction in oil production by Saudi Arabia and sharply higher gas futures, up 23%. 


NatWest: Is it time to buy into gilt outperformance?

Strategists at NatWest today reflected on the price action last week when gilts surprised the bank by modestly outperforming rival core bond markets.


Noting that the move was part of a broader fixed income rally triggered by events elsewhere (risk-off after debt ceiling negotiations concluded and the downside surprise in euro area inflation), NatWest said that gilts' outperformance nonetheless poses questions.


“After such large outright and cross-market moves in recent weeks, and a major positioning washout, perhaps some outperformance should be expected (albeit still somewhat puzzling),” said NatWest.


It took a look at some of the current popular mooted reasons to be positive on gilts:


  • i) "Gilts look cheap… This is not untrue, but comparing current outright cheapening and cross-market cheapening with historic yield levels risks underestimating how much gilts could cheapen further, given these views will be calibrated on previous, lower supply regimes. 


  • ii) "Although we think any concerns that the current high level of yields could trigger a repeat of last year are misplaced, it could trigger alarm bells for some that would not want to be caught long and take the risk. Higher yields may conversely be a trigger for less, rather than more, demand as investors are unenthusiastic about catching a falling knife.


  • iii) "If LDI are unlikely to be forced sellers, the scope for a 2022 style sell-off is limited. We think a rise in yields from here is likely to be more gradual than last year, where the speed of the move in rates was as much of a problem as the level of rates that we got to.


  • iv) "Domestic, private-sector buying is offsetting losses from the natural buyers of gilts. Private investors have indeed been buying significantly more gilts this year, more than offsetting the loss of demand from overseas buyers. (However)…. Demand for private (non-financial) investors is likely to be concentrated much more at the short end of the curve, vs the demand from the natural buyers that it is replacing which tends to be considerably longer (not to mention that the maturity of supply is also much longer).


  • v) "Household/retail buying of gilts is picking up considerably. There has reportedly been a marked pick-up in retail interest in gilts. It's worth putting this into context though. Households currently own less than 1% of outstanding gilts.


  • vi) "Food price caps will work to bring down inflation more rapidly. I’m sceptical that any formal price cap will be introduced, but even informal pressure on retailers to bring cap prices on essential goods may not have the desired effect. Particularly if this raises prices on other goods to compensate."


“The market conclusion, then, is that we still have confidence in the bearish view. We target 4.6% in 10y gilts and think this should bring with it a steeper curve.”


New issues: TorDom, Close Brothers


  • TD Bank is on the brink of pricing a £850m, 5y Covered FRN at SONIA +70bps via Barclays, CIBC, HSBC, Lloyds and TorDom (B&D).  


  • Close Brothers has mandated BofA, JPM and UBS to talk to investors ahead of a planned 5y GBP-denominated bond issue.


  • Inchcape PLC late on Friday priced a £350m, June 2028 bond at gilts +245bps via BNPP (B&D), MUFG, NatWest and Santander.