Tricky reacceleration priced in for MPC
Today’s lower-than-expected unemployment and higher-than-expected wage inflation data was the straw that broke the camel’s back today, albeit a camel with more backs than humps and most of those already broken by other UK shocks over the last year or less.
The front end of the GBP fixed income curve pretty much collapsed, led by SONIA futures which traded in big size and in big ranges, with the Dec23 contract ending 31 ticks lower in over 125K, while Dec24 was -38.5 ticks at the close in more than 74K.
One seasoned gilt market participant said this evening that the sell-off today leaves the front-end of the GBP fixed income market, and the MPC, in difficult situations.
Looking at the broad UK inflation picture he noted that “you just can’t really argue with the data. So you might think base rate won’t go above 5%, or 5.5%, when the facts change, you change.”
He said that “clearly the BOE’s models have got this wrong, in difficult forecasting conditions. We’re now pricing the base rate hitting 5.75% in Nov/Dec and staying there for quite a while with none of the expectation for cuts that there is in the US market.” Dec24 SONIA is only implying a modest fall in Bank Rate in 2024 to around 5.30% by year end.
The problems then facing the MPC and the market are that “if the MPC were to get more aggressive with hikes, people would start believing inflation might be controlled and the urge to massively increase prices or wages would possibly fade. But when everyone expects inflation to rise they react accordingly.”
But… “if the Bank goes from hiking in increments of 50bps, then reduces that to 25bps as it has, then starts hiking by 50bps again, either next week or later on, then that send out an unnecessarily alarming message.” He noted that MPC pricing for the next three meetings shows rates going up by an accumulating 29bps, 65bps and 95bps, basically two 25bps hikes at least, plus a 50bps move.
Meanwhile, he said that gilts keep getting whacked as people are squeezed out of long positions and into new long positions. This may seem odd but he conceded that “if I was flat gilts now and had to take a position one way or the other I would go long. They’ve sold off so much and it’s not impossible that inflation can still post the big drops that were widely expected until fairly recently.”
In terms of other trades he said that even in these conditions, flatteners might just be coming to the point where they are overdone and certainly don’t look an attractive new trade to put on. The 2s/30s gilt curve flattened 22bps to -27bps today.
In other activity today, a quiet week of DMO issuance was interrupted by a £3.5bn sale of 3.25% 2033 gilts, which as a 10y benchmark is typically one of the easier sales. However, while attracting a decent 2.33 times bid/cover, the 4.351% auction yield was treated by some as slightly disappointing and it ended the day at around 4.42%. “Not great,” was this source’s conclusion.
Swap spreads were unsurprisingly wider in that 2y sector, pushing up by 7.5bps to 51.3bps, while the 5y ASW -3bps at 10.5bps, 10y was +0.6bps at 11bps and the 30y was -0.7bps at -57bps. 2y spreads are now about 45bps richer than at their mid-April lows, while 5y has cheapened by 20bps over the same period, and by 50bps since the start of 2023.
Perhaps reflecting the nuanced impact of rate hikes on inflation, especially given some of the external drivers of UK price levels, RPI swaps were relatively calm until after the US CPI data, with the 1y +11bps at 3.68% as gas and oil futures surged, 10y was +7bps at 3.87% and the 30y was +4bps at 3.47%.
Barclays: Don’t panic, despite UK earnings, employment data
Today’s UK earnings and employment headlines raised the outlandish possibility that recent talk from former MPC superhawk, Andrew ‘Death’ Sentance, of UK rates hitting 6% (see GBP Swaps: Gilts dance to the beta as Death speaks) might actually be plausible.
Fortunately, strategists at Barclays today were in no mood to hit the panic button, despite average weekly earnings rising 6.5% in April versus a forecast 6.1%, and unemployment dropping from 3.9% in March to 3.8% in April, undershooting the 4% average forecast.
In summary, Barclays acknowledged enhanced hiking risks after the data, but stick to its guns when it came to its MPC forecasts. Barclays said that “The most eye-catching feature of the report was wage growth which surprised sharply to the upside and has shown a concerning reacceleration on a sequential basis. Today’s private sector wage growth print is likely to have surprised the BoE to the upside: assuming no downward revisions, May and June would need to both print -0.5% m/m for the Bank’s 6.3% 3m/y forecast for Q2 to be realised.”
However, Barclays concluded that “overall, today’s print is consistent with our view that the BoE will deliver more monetary tightening from here to lean against risks of medium-term inflationary persistence above the 2% target. Our call remains for two more 25bp hikes at the upcoming two meetings in June and August leading to a terminal rate of 5%.”
New issues: Anglian, BT, Aster, eSure
- Anglian Water has priced a £860m Green Bond consisting of an £300m 8y tranche at gilts +145bps and a £560m 16y tranche at +138bps. Via ING, JPM, Santander and SMBC.
- British Telecom has priced a £700m, 60.5y NC5.5 Hybrid Bond issue (Ba1/BB+) at 8.5% and gilts +382bps via Barclays, BNPP, BofA and JPM.
- Housing association Aster Treasury PLC has priced a £250m, 9.5y Senior Secured (A+) Sustainability Bond via Barclays and Lloyds at gilts +110bps.
- Reigate-based vehicle insurance company eSure has priced a £100m Tier 2 sub 10.5y NC5.5 12% bond at par via MS.