UK: Pricing future data weakening – Deutsche Bank

According to Jack Di-Lizia, Strategist at Deutsche Bank, continued richness of UK fixed income points to the market pricing a deterioration in the economic outlook together with a BoE that is unlikely to turn hawkish.

Key Quotes

“Recent data has however been more mixed.  There are signs higher inflation may be weighing against consumption in particular, but this week’s PMIs highlight some reversal in the weakening seen over February.”

“Front end pricing is now broadly in line with that seen at the November Inflation Report, with the first 25bp hike now pushed back to June-19.  The 1Y1Y point remains cheap however, while the pace of hikes further out following the first move has flattened excessively.  We stay received 1Y1Y sonia on the fly vs 1Y and 2Y1Y.”

“Further out, Gilts remain rich on a cross market basis, with real rates rallying this week in line with November levels.  With the curve now excessively flat to models, we maintain the UKT 5s10s steepener.”

“GBP swap spreads have seen significant richening since the start of the year and we take stock of current valuations.  Our framework suggests long end swap spreads remain cheap relative to 5Y spreads while 10Y ASW have now corrected the excess cheapening seen in Q4 of last year, although directionality to the level of yields remains.  Improved Gilt funding conditions, potentially supported by increasing takeup of the BoE’s TFS scheme, represent one of potential drivers of the recent spread richening.”

“The rally in Gilts and associated curve flattening has significantly increased the chance that the Gilt future CTD switches from the 4.25 27s to the 1.5 26s for June delivery.  A further 1.5-2bp flattening of the slope between the two bonds would generate such a switch.  As a result, a continued richening in gilts should drive 1H26 basis towards zero.”

“Given the risk of a change in CTD to the 1H26s, we exit the short 2t 24 vs 2q 23 and 1h 26 following the recent cheapening of the bond.  With quarter end now passed and limited sign of a catalyst for short dated collateral richening, we also exit the long 2Y ASW vs. 5Y.”