GBP Swaps: Long end LDI talk amid big flattening

Long end LDI talk amid big flattening

In a move that will offer little cheer to those calling time out on the recent curve flattening (see next section) the GBP fixed income curve put in a big flattening shift today, with 30y yields down by 6bps and 2y pushing 8bps higher, dragged there largely by an 11bps sell-off in the Schatz which itself was driven by an ECB day that leant on the hawkish side.

A couple of weeks ago, one senior gilt trader at a London-based GEMM told Total Derivatives (see GBP Swaps: Long end feast and famine) semi tongue-in-cheek, that June would see a lot of flattening pressure led by the long end as LDI piled back into long gilts secure in the knowledge that there is little issuance of such assets this month, only to be burnt badly when a torrent of long and ultralong gilt sales is unleashed in July.  

Many a truth though is said in jest, and it seems like Stage One of this strategy is now underway, or at least is being prepared for by advance parties. One long-suffering swapper today said that asset managers (a group incorporating a significant proportion of LDI investors) have decided that after widening 100bps versus Bunds in the last month alone, gilts are now back on the ‘buy’ list after more than eight months on the naughty step following last Autumn’s Truss interregnum.

He told Total Derivatives (see Basis: Is this the end of the Truss 30y cable collapse?) that following an FT story announcing the imminent return of asset managers to gilt-buying, front-runners and possibly asset managers had driven a sharp reversal of long-end cable basis curve flattening. The cable curve has been absolutely crushed this year as these asset managers eschew gilts in favour of trusted non-UK government bonds, and then swap the cashflows back to GBP.

But signs of a reversal of that long-standing trend are being echoed (or more likely led) by shifts in the gilt curve. A mixed bag of US data today offered hope for both doves and hawks, but it was noticeable that the biggest ‘misses’ from headline forecasts were both to the upside – in retail sales and the Empire Manufacturing index.   

A rally in USTs that has likely supported a comparable move in gilts (30y UST yields are currently -5bps whereas the 30y gilt is -6bps) but the 10s/30s curve is a touch steeper in USTs, while it is 5bps flatter in gilts, so, amid a lack of UK data today, something else is going on than just US numbers. 

Elsewhere, and one other pressure on the very weak front-end, apart from the ECB and rising MPC hike forecasts, was supply in the form of the £770m APF unwind sale of 2026-2029 gilts. The sale itself received a respectable 2.14-times bid/cover ratio, with the shortest gilt on offer – the 1.5% 2026 – receiving the second largest number of bids (£356m versus £534m for the 1.625% 2028) but having the most accepted (£333m versus £176m for the 2028).

At a time of widespread MPC panic post the recent April wages and employment data, the front end had a wild ride today, exacerbated no doubt by the APF event. The 1.5% 2026 for example had sold off 11bps before the APF operation, to reach 4.82%, before being sold at around 4.75% and then closing at 4.75%, about 4bps higher on the day despite outperforming on the curve.

By the end of a day of substantial flattening, 2y ASW is +3.6bps at 52.4bps, 5y is -2.6bps at 7.6bps, 10y is +0.5bps at -10.7bps and 30y is -0.9bps at -57.8bps. Dec23 SONIA was -3.5 ticks today while Dec24 was -7 ticks. Inflation continued to flatten with 1y RPI +17bps and 30y -4bps as long nominals gained and energy prices rose. 

MS: Taking the hit and sticking to steepeners

While most GBP fixed income strategists were busy today and yesterday penning predictions of a 25bps rate hike next week with 1-2 votes for 50bps and hikes continuing into unknown territory somewhere above 5%, the plucky team at Morgan Stanley went their own way, making a defiant defence of their call for 5s/30s steepeners despite the curve being badly squished of late.

MS said in research published late yesterday that “following a significant bear-flattening of UK rates on the back of stronger-than-expected April labour market data, we extend our 5s/30s gilt steepeners stop loss, given we believe conditions remain supportive for a steeper curve.”

Given that since May 15, exactly a month ago, the 5s3os gilt curve has flattened 13bps to just 2bps, led by a healthy 88bps sell-off in 5y yields, this is a plucky shout. MS said that having entered the steepener on Jun 6, “we continue to believe conditions still support our 5s30s gilt steepeners, while current valuations improve the risk-reward profile.”

It cites the following as reasons to maintain its trade:

• "The repricing in higher front-end yields has been significant, with levels now at those last seen during the mini-budget crisis. Valuations are discounting higher-for-longer rates, with the terminal rate now priced in February 2024. Given current valuations, we believe risks are tilted towards lower front-end yields.

   

• "Positioning in front-end rates is likely to be clean now as the majority of those who played a bullish front-end view must have been stopped out, given the significant repricing in higher short-term rates.

   

• "The inflation outlook remains uncertain but this should be already discounted in inflation expectations, given the sub-1-year RPI fixing having repriced substantially higher over the last month. The significant gilt supply in the 30y sector should weigh on long-end gilt valuations, supporting a steeper curve; according to the issuance calendar for the upcoming quarter (July'23/Sep'23), the 30-year sector will be frequently tapped and additional supply might come from the linker syndication in July 2023, (the IL45 is a strong candidate) as well as from the nominal syndication in September 2023.

   

• "Seasonality in July, points to a steepening of the SONIA 10s30s,as this has occurred 88% of the time since 2007."

New issues: SocGen, Volvo

• SocGen has priced a £500m, 10y at gilts +190bps. Via NatWest, Nomura, Santander and SocGen.

   

• Volvo is on the brink of pricing a £300m 5y bond at gilts +145bps via HSBC, NatWest (B&D) and UniCredit.