GBP Swaps: Underperformance extends as curve bull-steepens

BOE facade
Gilts’ ability to underperform in selloffs and rallies remained impressive this week, with the curve bull-steepening today.

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  • Underperformance extends as the curve bull-steepens

  • How long is this going to take? Barclays


Underperformance extends as the curve bull-steepens

Gilts’ ability to underperform in selloffs and rallies remained impressive this week, with the spreads to 10y Bunds pushing out again to around 206bps (+2.5) today, from 190bps a week earlier. The gilt future opened at near to the day’s highs following overnight gains for USTs and weakness in global risk assets but this strength faded as the session continued and the contract was +49 ticks at the time of writing, about 30 ticks off the day’s peaks.


In the news, weaker-than-expected UK retail sales (-1.2%mom versus the -0.6%mom consensus) was partly blamed on wet weather and SONIA futures only managed a tepid recovery from recent losses, with the whites +1-5 and the reds +4-6 ticks, leaving the implied ‘terminal’ BOE rate still just above 6% for early 2024.


Along the curve, 2s/10s gilts bull-flattened in the morning and then steepened through the afternoon to finish at -49.9bps (+1.4). Asset swaps were little-changed at 34.7bps (-0.6) in 5y and -59.8bps (-0.5) in 10y. 


Further out, 30s/50s continued to steepen ahead of next month’s DMO syndication in line with suggestions by RBC earlier this week (see Total Derivatives GBP Swaps). 30s/50s gilts rose by a bp to -46.4bps.   


With oil and gas futures holding in their recent range, RPI swaps fell slightly led by the front end as updated estimates of the Ofgem energy price cap. RPI 1y fell by 2bps to 4.02% versus a 1bp dip in 30y to 3.42%.  


How long is this going to take? Barclays

A reappraisal of how long the MPC might be willing to stay at restrictive levels will likely put 1y1y “under pressure in RV structures” rates strategists at Barclays suggest this week.


Near term, although the outside risk of of a 50bps BOE hike is now priced for the next meeting (Sep23 MPC SONIA today implies a +32bps hike in BOE Bank Rate to 5.57%), Barclays judges that there has “probably not” been enough upside news on the economy for the MPC to “accelerate its pace of tightening to 50bp per meeting”.  The bank continues:


    “Our sense is that the market is trading the immediate meetings from the long side as it seeks to fade expectations for both a 50bp hike at the upcoming September meeting and successive sequence of hikes. Of the two options, we would think that market interest would be more focused on fading September, which seems like a safer option to us as there is only a single further data cycle to go through ahead of the meeting…The positional pain trade remains a continuation of the sell-off in the very front end (sub-12m) of the curve.”


If the BOE wants to maintain a restrictive stance for a “sufficiently long” period of time, the MPC will move more towards “emphasising the need for a extended period of restrictive policy rather than the degree of restrictiveness,” Barclays suggests. Thus BOE officials may choose to focus:


    “…More on the term structure of expectations and trying to reshape expectations for easing from mid-2024. From a market perspective, this is likely to place bearish pressure on GBP1y1yf in relative value structures. GBP1y/1y1yf/1y2yf butterfly has most recently reversed its recent richening as the repricing of the terminal rate has pushed the entire term structure higher. In mid-July, the fly peaked at a cycle-high of around +75bps. A reassessment of the willingness of the MPC to stay on hold at restrictive levels will inevitably place the belly of the fly under pressure and see GBP1y1yf underperform the wings.”