GBP Swaps: Flatter, underperforming; Inflation trades

BOE Threadneedle street Oct 2022
Gilts are underperforming Europe and the curve is flattening from the front end again as the market heads towards the weekend.

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  • Flatter, underperforming

  • Linker opportunities: Banks  

  • New issues


Flatter, underperforming

Gilts and England’s batsmen are both back to underperforming at the time of writing although against Europe for gilts (see Total Derivatives) rather than Australia. The future is down 20 ticks while spreads to 10y Bunds are 4bps wider at 192bps.


Along the curve, SONIAs are another 2.5-4 ticks lower as next week’s CPI data and MPC meeting loom, and 2y yields are edging up to 4.94% (+4bps). The long end has slipped out of the green with the 30y at 4.52% (+2bps), lagging the bull-flattening in Bunds. Gilts 2s/10s is down to -53.2bps (-2.0) and 10s/30s is 11.4bps (-0.4) but the ultra-long end is also flattening further, with 30s/50s at -44.9bps (-1.2).   Asset swaps are cheaper at the front end and little-changed further out with the 10y at -9.4bps (+1.2) and 30y at -58.0bps (-0.2).


Linker opportunities: Banks  

Short RPI is a touch softer and consolidating recent gains after surging by 50-60bps since the start of the month and breaking above 4% in 2y yesterday. The move was supported by a 50% climb in Dutch gas futures since early June but the future has slipped to around €36 (-15%) today. In the news, Tesco today reported "early signs that inflation is starting to ease across the market." 


Ahead, the inflation data are due next week with the Bloomberg survey consensus looking for RPI to slow by 10bps to 11.3% compared to pricing of around 11.2% in the reset market. In the meantime, Bank of America and Barclays both see opportunities in the front of the inflation curve.


BofA recommends paying the forward real yield between IL27 and IL32 because the UK will need “meaningfully higher” real policy rates to keep inflation in check and attract financing for the “persistent” current account deficit. It continues:


    “The market prices future reductions in interest rates, but not the moderation in inflation to justify it. We choose to express the view in forward rather than spot terms because of the all too clear and present danger that further upside surprises in reported RPI prints deliver punitive adverse carry for a bearish spot real yield trade”


BofA also points to a “material RV dislocation” and cross-market comparisons:


    “Although the forward real yield from UKTi 2027 to 2032 has risen since April, the anomaly on the curve seems even more stretched than then. One aspect of this is the cheapness of linkers on ASW at the front of the curve, relative to those around the 10-year area and immediately beyond… (And) the real swap curve in the UK is priced to shift from meaningfully higher than Euro now to meaningfully lower than Euro.”


The bank also sees 'flows' as potentially supportive for the trade:


    “This month sees the launch of a new 10y linker, which will be reopened in August. More generally, July is set to see very heavy issuance for gilts overall in duration terms. These should be forces for steepening out to 10y in the real curve, lifting our forward yield, we expect. And August sees IL28s exit the Over-5y index; as a relatively short-dated issue within the over-5y range, IL32s might suffer as a result of investors rebalancing longer.”


Elsewhere, Barclays spots a dislocation in the RPI curve, which implies inflation “will re-accelerate in late 2024, before decelerating once again.”


    ”RPI fixings out to 24 months shows an apparent dislocation emerging around the December 2024 fixing. Currently, the market is priced for RPI y/y to decelerate to 3.3% by mid-2024, only to then accelerate to 4.9% y/y by December 2024 and then fall back to the low 4%s just a few months later.”


The bank acknowledges that liquidity constraints make fading this pricing dislocation difficult but is looking at “shorting the Dec 24/Dec 23 RPI swap forward against 2yfwd3y RPI, or something similar” rather than a directional outright view”.


New issues

  • Volvo yesterday priced a £300m 5y 6.125% due Jun 2028 at gilts +145bps via HSBC, NatWest (B&D) and UniCredit.


  • Bank of Nova Scotia yesterday priced a £125m 1y FRN due Jun 2024 paying SOFR +50bps. Self-led.