GBP Swaps: Wages of fear, but PM sees progress on inflation

Sunak beer 1 Aug 2023
RPI swaps were mixed today in the wake of the strong average earnings data and another pop in natgas futures. Still, PM Rishi Sunak is optimistic.

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  • Wages of fear, but PM sees progress on inflation

  • L&G expects up to £11bn PRT 

  • NatWest: Don’t be tempted until you see 10y gilts at 4.9%  

  • New issues: NIB


Wages of fear, but PM sees progress on inflation

An acceleration in average earnings growth to 8.2%, sharply above the market forecast of 7.4%, unsettled the front end of the curve from the open today, even after losses yesterday. Sep23 SONIA slumped to test 94.02 following the numbers before recovering through the afternoon in the wake of mixed US data, with the future finishing around 94.11, down 9 ticks in volume of 105K. The SONIA forward curve is now pricing a total of nearly 75bps in BOE rate hikes by Feb24, including 53bps by the time of the Nov23 MPC meeting.          


Elsewhere, the curve was mixed: while 2s/10s bear-flattened to session lows before lunch and then flattened again until shortly after the close, 5s/10s and 10s/30s both recovered from opening lows as the day wore on, eventually ending little-changed at -0.2bps and 18.9bps respectively.  


In supply, the DMO sold £2.5bn in 1.125% 2039 gilts with close to average bid/cover of 2.51 and an unspectacular 0.8bp tail. The bond ended the day slightly cheaper on the curve.


RPI swaps rose 1-2bps out to 2y but fell by 2-4bps at 5y and beyond following the wages data and ahead of the inflation numbers tomorrow. Still, the RPI fix edged a touch lower to around 8.79% on the screen after trading at 8.81%, 8.8%, 8.805% and last at 8.81% in £120m. In the background, losses of $1.8 for Brent were offset by a 13% pop in Dutch gas futures as Australia’s LNG supply strike talks extended. 


Ahead of the inflation report, which is expected to show CPI slowing to 6.7% from 7.9% and RPI dropping to 9.0% (above where the fix traded last) from 10.7%, PM Rishi Sunak told broadcasters today that "We are making progress…The plan is working. I think there is light at the end of the tunnel." Given 2023, it’s probably an approaching train but perhaps his pre-release optimism will be rewarded.     


L&G expects up to £11bn PRT

Legal & General’s shares were down 2.6% today after the insurer/fund manager announced a 2% drop in H1 2023 operating profit to £941m.


The insurer said that from an estimated £1.4tn of UK DB pension liabilities, only an estimated c15% has been transferred to insurance companies to date. Demand for demand for Pension Risk Transfer (PRT) is growing “as rising interest rates and widening credit spreads reduce pension deficits and allow more funds to consider de-risking options,” L&G said. It continued:


    “Our stated ambition is to write circa £8-10bn of UK PRT per annum and we are confident of achieving this.


    “We have demonstrated that this level of new business is self-sustaining, i.e. the growing amount of capital generated by our in-force UK annuity book more than offsets both the capital investment required to fund new business and the portfolio’s contribution to our progressive Group dividend.


    “The UK annuity portfolio achieved self-sustainability in 2020, 2021 and 2022. Over the period from the beginning of 2020 to H1 2023, Group net surplus generation has exceeded dividends by a total of £0.6bn. For 2023 as a whole, we currently have capacity to write up to £11bn of UK PRT and still achieve self-sustainability for the UK annuity portfolio.”


Along with activity in the US and Canadian de-risking markets, Legal & General suggests that pension reform legislation in the Netherlands could result in “significant PRT business coming to market over the next 3-4 years…With pension liabilities of over €1 trillion, we continue to actively monitor this market and have announced plans to enter into a long-term strategic relationship with Lifetri in order to participate, should attractive opportunities arise.” L&G added that it has been “actively pricing” in the Dutch market.


NatWest: Don’t be tempted until you see 10y gilts at 4.9%  

The generally bearish team at NatWest highlight that 10y gilts have reached their 4.6% estimate of fair value (again) in the wake of this morning’s average earnings data. But the bank suggests there could be more to come from here, and only likes 10y gilt longs around 4.9%. It explains:


    “The combination of upside surprises on growth and inflation data and the weight of supply have all driven gilt yields higher once again, now trading just above our fair value estimate of 4.6%.


    “There are plenty of reasons to think that gilt yields can overshoot this fair value, though, and we re-iterate our call that we don’t see reason to fade the cheapening until 10y gilts get to 4.9%. The risks are now three-fold:


  • "Upside surprises in the data call into question the BOE’s new, dovish reaction function. Further tightening is going to be required.

  • "Supply risks are skewed to the upside, and supply fatigue is already apparent.

  • "Demand remains weak, and the more that the data surprises to the upside and the monetary policy outlook diverges from the rest of the world, the more that buyers of gilts remain on the sidelines.


    “Another ~£30bn increase in net supply and an additional 25bps hike versus our base case of a 5.5% peak would add ~20bp to our fair value estimate for 10y gilts…Current bearish momentum can push gilts to ~4.9% before we’d look to fade the cheapening.”


New issues: NIB

  • NIB sold a £25m tap of its 3.875% Feb 2026 note via HSBC.