UK rate markets reacting less this time around – TDS

Research Team at TDS, suggests that given higher odds of a Remain outcome in the EU Referendum (of 77%) and more hawkish Fed minutes, UK yields have drifted higher.

Key Quotes

“However the moves are less extreme then they were last time the odds were close to these levels. Given this we see opportunities for UK rates to rise a little further from here however we prefer positioning for this relative to US rates (which have risen recently due to greater Fed hiking expectations, and look more fair) as opposed to outright given the move higher that we have already had.

When betting odds were close to these levels during Obama’s visit (odds at 75%) in late April, the move higher in UK rates was sharp and fast—with the 10y and 2y reaching a peak of 1.66% and 0.55% respectively and markets pulling forward the timing of the first hike to 22 months (from 51) in the space of a couple of weeks—currently it is still extreme at 41months.

We believe that the move in UK rates this time has been less sharp because of two reasons: 1) UK data is weaker on average and 2) event risk with the Referendum vote closer. Even though this can make the outright move on UK rates less sharp, we believe that the relative value trade against the US remains compelling.

Market sentiment on the Fed hiking cycle has changed after the hawkish Fed speak and April Fed minutes with now a full hike priced in for this year. However, UK rates have lagged despite higher betting odds and a clearer Remain lead in the polls. Thus we like positioning for a narrowing in the 10y US-UK bond spread. The spread at the 10y point is at 40.5bps (the high was 48bps in late March). We enter 50k DV01 of short 10y gilts vs. long 10y Treasuries at current levels of 40.5bps, with a target of 25bps and a stop loss of 51bps.

We would stress that this is a tactical opportunity given the drift higher in both betting odds and in Fed hiking expectations. Closer to the Referendum vote in June we would expect to see uncertainty over the vote outweigh betting odds. Given significant and binary event risk around the Referendum, we look to take this trade off before the vote.”