GBP Swaps: Sloppy longs retreat in thin market

Sloppy longs retreat in wafer-thin market

With the 10y gilt yield having rallied from 4.56% on Sep 6 to just 4.24% yesterday morning, the gilt market has engaged in some well-deserved profit taking amid the generally bullish global fixed income drift of the last few days. Currently it is +6.5bps at 4.34%, while the 2y yield has made even bigger moves since Sep 6, rallying 43bps, and today it is up by 5.5bps at 4.98%, while even the 30y managed a 20bps rally since those Andrew Bailey comments about rates being near the top of the cycle nine days ago. The 30y yield is currently +5.8bps at 4.66%.  

Gilts outperformed all-comers as rates generally sank over the last two weeks, so it seems only fair that they have under-performed on a day of rising yields across the boards. Today’s moves have come in something of a void in terms of flow and drivers.

One seasoned gilt trader said this lunchtime that “I’m back from holiday today and was expecting usual September conditions – which are busy, but fun. But this feels like full-on Summer trading.”

As for the directionality he said “all the markets are behaving the same and everyone’s scratching their heads. I think blaming the FT’s ECB story (ECB hawks claim Dec hike on the cards) is a bit weak. I think it’s more that there is profit-taking and also there are lots and lots of sloppy longs out there and in a thin market the market hunts for a point of weakness.”

Looking ahead, he said that “the UK data’s been pretty rubbish so I think the bull-steepener is still very much on, once things get back to normal next week.” As for today’s move, it could of course all change in a matter of minutes when a raft of US data (UofM sentiment and industrial production and capacity utilization numbers loom), but it sounds like it will take quite something to stir up gilt action. Currently gilt futures volumes are just 85K.  

In swap spreads the curve has steepened with 2y -1.2bps and 30y +0.6bps. In inflation, linker breakevens are +2bps across the curve.

Citi: ‘Higher for longer’ MPC stance doesn’t wash

Strategists at Citi today re-affirmed their dovish stance regarding UK bank rate in the year ahead, saying that while the narrative generated by the MPC lacks clarity, it’s recent drift towards a ‘high for long’ approach lacks plausibility.

Instead, Citi says that with the market having only recently re-priced the peak rate to around 5.60% (currently 5.25% with a 22bps hike priced for Sep 21), its next calculation will be what the timing and extent of rate cuts will look like.

It says there are “still only 60bp cumulative cuts priced in for 2024. ‘Only’ gives away our bias that this could be significantly more (the official house view is for 200bp of cuts in 2024). Cut pricing for the BoE still stands out as low relative to the ECB (currently 73p) and especially the Fed (over 100bp). This has been true all year, but as the market gains confidence the terminal rate is near, the likely next step will be to recognize that the BoE can cut at least as quick as the others.”

For now, it says, “the BoE appears to be shifting to a higher-for-longer narrative to provide cover for a pause. We doubt it will stand the test of time, however. Higher-for-longer is more a snapshot view than a genuine attempt at forward guidance (the official wording in the policy summary of “sufficiently restrictive for sufficiently long” really covers all bases). And we suspect it breaks fairly easily as inflation recedes and the policy emphasis starts to pivot to weaker growth (like the ECB).” In conclusion Citi makes these three market recommendations:

• "The potential for the market to soon focus on 2024 cuts, and discount ‘higher-for-longer’ should help propel further cross-market outperformance of GBP front-end forwards toward more historical norms.

   

• "It also gives us more confidence in our already bullish bias for gilts, forecasting 3.95% for 10s at end-2023 then pencilling in 3.3% at end-2024 (vs 4.28% as of close 14Sep23).

   

• "This is likely front-end led and our forecast profile envisages the 2s10 gilt curve to dis-invert to +30bp in H2 2024 (currently -67bp as of close 14Sep23)."