By Dan Barnes and Etienne Mercuriali
Gilts market opening on the morning of 9 January suggested some traders took a big hit, with stop losses executed on open, as the market dropped down to 89.02, or 40 basis points in the first few minutes of trading, before recovering more in line with European counterparts.
The activity occurred as the UK government saw borrowing costs spike, while other governments saw costs rise to a lesser degree.
“Since the start of the year we have seen 10-year gilt yields move from 4.58% to a high on today’s open of 4.92%, at the same time German yields have moved a lesser amount from 2.37% to a high of 2.57%,” says Paul Goss, head of macro trading at Ucapital Asset Management.
He also notes that the move has spooked the currency market, with euro/sterling rallying 1.5% in the last two days.
“We would expect investors to be buying gilts ahead of psychological levels of 5% in 10-year and 4.75% in five-year,” he added.
Analysis by trading data specialist Propellant, of dealer to client (D2C) real time reported trading activity by both voice and electronic means – excluding Debt Management Offices and similar public bodies responsible for public debt management – saw market activity varied wildly between different rates markets.
While European government bond trading volumes increased by 0.06% between Tuesday 7 January and Wednesday 8 January, UK gilts activity increased by 26% and US Treasury trading fell by 1.66%.
While sterling and gilt yields calmed down during the day, following statements made in the UK in parliament, traders will still be wary of signals for further moves.
“Ahead of upcoming US jobs data followed by UK CPI next week, ongoing political tensions both at home and abroad in the USA with Musk, traders will be looking for further moves in higher yields and lower pound,” Goss says. “The UK mix of low growth, high inflation and high debt is a perilous situation that investors will be very wary of for the future and a big test for the Labour governments economic plans.”
At UBS, interest rates strategists noted there were several reasons for Gilt yields to be spiking.
“They need internationally price sensitive buyers and US Treasuries are tough competition at the moment. The back story for UK duration is weak since pensions were filled, but the call on investors will be greater than in the US or Europe this year as a proportion of GDP,” they wrote. “Indeed, supply will be very heavy in Q1 by even last year’s standards. Prices will balance the market at some level, of course, but we are not sure we’re there. Fundamentals still look bad. Confidence in a path to substantially lower policy rates is needed. We expect we’ll have that this year, but don’t expect it to come quickly. Confidence in the fiscal path is also needed. Lower rates would help. But it looks increasingly like market pressure will test the Chancellor first and real fiscal adjustments aren’t likely soon.”
The obvious parallels between the current situation and the gilt crisis in 2022 under Liz Truss’s disastrous mini-budget were tackled by Agne Stengeryte and Mark Capleton in the rates team at Bank of America who observed several important differences in a research note.
“This is much more a global move, with the UK underperforming, whereas 2022 was home-grown. This week’s market has seen speculative positioning as a driver, whereas 2022 was a structural problem related to one investor base. These moves are much more gradual than in 2022. The limited Gilt ASW moves seen this time around are also unlike the mini-budget episode – the market distress is a much lower order of magnitude.”
They noted three factors as potentially explaining the higher than usual beta of Gilts to US Treasuries:
- The market prioritising inflation concerns over any negative growth impact from potentially needed fiscal consolidation;
- Gilt supply fatigue; and
- Positioning.
“Two-year and thirty-year underperforming the most is consistent with inflationary concerns for the front-end, and a supply-demand imbalance for the 30 year,” they wrote.
They said they favoured three existing trade ideas at present:
- A one-year forward 2s10s Sonia steepener entered at -1bp on 8 November with a target: 25bp and stop: -15bp. With the risk to the trade being further front-end repricing higher.
- Pay 5-year real Sonia entered at 1bp on 12 July with a target: 60bp. Stop: -30bp. Current: 30.6bp. Risk to the trade is recessionary threat.
- Pay 5y real Sonia, receive 5-year real Estr entered at 43bp on 21 August. Target: -40bp. Stop: 90bp. Current: 0bp. Risk to the trade is recessionary threat.
Meanwhile the UBS team flagged two possible trades:
“2s10s steepeners: The curve is more likely to continue to steepen in its quest for buyers, we think. Ideally that would be the bullish kind, but it might well not be,” they noted. “Or, short 10 year in the 5s10s30s fly… If buyers come, we think they are most likely to be drawn either to long-end forward valuations and convexity, or to the front end in the hope of a rates cycle. Meanwhile supply is heaviest in 10 year and 15 year this month. 5s10s30s SONIA looks attractive.”
