Head of Fixed Income Strategy
1. Increased Odds for BOE Rate Cuts: The market is now pricing in a 50 basis points rate cut by the end of the year, up from 45 bps, driven by recent labor and inflation data. However, a rate cut in September is considered unlikely, with only a 40% probability.
2. Inflation and Labor Data Concerns: While the inflation report and labor data appear positive at first glance, they may not be as strong as they seem. Inflation, though slowing, has pockets of persistence, with core and services CPI well above target. Additionally, changes in benefit eligibility criteria may have artificially inflated the Claimant Count, casting doubt on the true state of the labor market.
3. Divergence Between Gilt and Swap Markets: There is a notable divergence between 2-year Gilt yields, which have dropped significantly, reflecting pessimism about the economic outlook, and the swap market, which hasn't shown the same level of concern. This has led to a widening of the 2-year UK swap spread to 44 basis points.
4. Investment Strategy and Inflation Risks: A cautious buy-and-hold approach is preferable. For 2-year Gilts at 3.5%, yields would need to rise significantly before incurring a loss. However, if inflation remains stickier than expected, markets may resist aggressive BOE rate cuts, potentially impacting long-duration positions.
Odds for the Bank of England (BOE) interest rate cuts by the end of the year have risen slightly following the release of the latest labor and inflation data. Markets are now pricing in 50 basis points (bps) of rate cuts by year-end, up from 45 bps on Monday. Despite inflation slowing down faster than expected and the UK Claimant Count rate rising to levels reminiscent of the Global Financial Crisis (excluding the pandemic spike), markets are not yet anticipating a BOE rate cut in September, with the probability of a September rate cut standing at 40%. Why?
One reason may be the skepticism surrounding the reliability of the current Claimant Count numbers. The Department for Work and Pensions has increased the administrative earnings threshold for full work search conditionality. This policy change means more individuals must meet specific conditions to receive benefits, particularly those earning below the new higher threshold who now need to actively search for work to continue receiving benefits. This adjustment might have artificially inflate the Claimant Count, making it a less reliable indicator of labor market distress.
Additionally, when examining UK inflation data, although the headline, core, and services inflation readings came in below expectations, some troubling signs persist. The Headline Consumer Price Index (CPI) rose from 2% in June to 2.2%. Meanwhile, core and services CPI remain well above the BOE's target, at 3.3% and 5.2% respectively. Concurrently, the UK Retail Price Index (RPI) exceeded expectations, rising to 3.6% from 2.9% in June, reversing the downward trend seen since the first quarter of last year.
Since the end of May, 2-year Gilt yields have dropped by 100 basis points, declining from 4.5% to 3.5%, reflecting growing pessimism about the economic outlook. Investors seems to anticipate lower growth, reduced inflation, or a potential recession, which has driven them to seek the safety of government bonds.
In contrast, the swap market, while also sensitive to economic expectations, has not mirrored the same level of pessimism. This disparity has led to a widening of the 2-year UK swap spread. Initially falling into negative territory during the first quarter of the year, the spread has since risen to 44 basis points.
Swap markets are influenced by different dynamics than cash markets, such as hedging activities and specific behaviors of market participants. The divergence between the two suggests either that bond markets are prematurely pricing in a gloomy economic outlook or anticipating a sudden defeat of inflationary pressures, or that the swap market is overly optimistic about the economy or still concerned about persistent inflation.
While it's uncertain who is right or wrong, a cautious buy-and-hold approach remains prudent. At 3.5%, 2-year yields still offer an appealing risk-reward ratio. Assuming a one-year holding period, yields would need to rise above 11.6% before the investment incurs a loss. In contrast, 10-year yields, currently at 3.85%, would enter the red if yields rise above 4.4%. I If inflation proves to be stickier than expected, markets are likely to resist an aggressive BOE interest rate cutting cycle, putting pressure on positions carrying long durations.
09-Aug Yield Curve is Disinverting: Lessons from Past Crises
07-Aug Stable Bond Spreads and Robust Issuance Make a 50 bps Rate Cut in September Unlikely
06-Aug Insights into this week's US Treasury refunding: 3-, 10-, and 30-year overview.
05-Aug Why Investors Must Pay Attention: BOJ’s Hawkish Moves Could Roil Global Markets
30-July BOE Preview: Better Safe than Sorry
29-July FOMC Preview: A Data-Dependent and Balanced Approach
24-July Market Impact of Democratic vs. Republican Wins
23-July Insights into this week's US Treasury auctions: 2-, 5-, and 7-year overview.
16-July Insights into this week's US Treasury auctions: 20-year U.S. Treasury bonds and 10-year TIPS.
15-July ECB Preview: Conflicting Narratives – Rate Cuts vs. Data Dependency
15-July Understanding the "Trump Trade"
11- July Bond Update: Faster Disinflation Paves the Way for Imminent Rate Cuts, but Risks of Economic Reacceleration Remain
09-July Insights into This Week's U.S. Treasury Auctions: 3-, 10-, and 30-Year Tenor Overview and Market Dynamics.
08-July Surprise Shift in French Election Fails to Rattle Markets for Good Reasons.
04-July Market Optimism Ahead of French Elections Drives Strong Demand for Long-Term Bonds
01-July UK Election Uncertainty and Yield curve Dynamics: Why Short-Term Bonds Are the Better Bet
28-June Bond Market Update: Market Awaits First Round of French Election Voting.
26-JuneBond Market Update: Canada and Australia Inflation Data Dampen Disinflation Hopes.
30-May ECB preview: One alone is like none at all.
28-May Insights into this week's US Treasury auctions: 2-, 5-, and 7-year tenors overview.
22-May UK April’s Consumer Prices: Markets Abandon Hopes for a Linear Disinflation Path.
17-May Strong trade-weighted EUR gives ECB green light to cut rates, but bond bull rally unlikely
14-May UK labor data and Huw Pill's comments are not enough for a bond bull rally
08-May Bank of England preview: Rate cuts in mind, but patience required.
06-May Insights into this week's US Treasury refunding: 3-, 10-, and 30-year overview
02-May FOMC Meeting Takeaways: Why Inflation Risk Might Come to Bite the Fed
30-Apr FOMC preview: challenging the March dot plot.
29-Apr Bond Markets: the week ahead
25-Apr A tactical guide to the upcoming quarterly refunding announcement for bond and stock markets
22-Apr Analyzing market impacts: insights into the upcoming 5-year and 7-year US Treasury auctions.
18-Apr Italian BTPs are more attractive than German Schatz in today's macroeconomic context
16-Apr QT Tapering Looms Despite Macroeconomic Conditions: Fear of Liquidity Squeeze Drives Policy
08-Apr ECB preview: data-driven until June, Fed-dependent thereafter.
03-Apr Fixed income: Keep calm, seize the moment.
21-Mar FOMC bond takeaway: beware of ultra-long duration.
18-Mar Bank of England Preview: slight dovish shift in the MPC amid disinflationary trends.
18-Mar FOMC Preview: dot plot and quantitative tightening in focus.
12-Mar US Treasury auctions on the back of the US CPI might offer critical insights to investors.
07-Mar The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.
05-Mar "Quantitative Tightening" or "Operation Twist" is coming up. What are the implications for bonds?
01-Mar The bond weekly wrap: slower than expected disinflation creates a floor for bond yields.
29-Feb ECB preview: European sovereign bond yields are likely to remain rangebound until the first rate cut.
27-Feb Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.
23-Feb Two-year US Treasury notes offer an appealing entry point.
21-Feb Four reasons why the ECB keeps calm and cuts later.
14 Feb Higher CPI shows that rates volatility will remain elevated.
12 Feb Ultra-long sovereign issuance draws buy-the-dip demand but stakes are high.
06 Feb Technical Update - US 10-year Treasury yields resuming uptrend? US Treasury and Euro Bund futures testing key supports
05 Feb The upcoming 30-year US Treasury auction might rattle markets
30 Jan BOE preview: BoE hold unlikely to last as inflation plummets
29 Jan FOMC preview: the Fed might be on hold, but easing is inevitable.
26 Jan The ECB holds rates: is the bond rally sustainable?
18 Jan The most infamous bond trade: the Austria century bond.
16 Jan European sovereigns: inflation, stagnation and the bumpy road to rate cuts in 2024.
10 Jan US Treasuries: where do we go from here?
09 Jan Quarterly Outlook: bonds on everybody’s lips.
Quarterly Outlook
Global Head of Macro Strategy
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Global Head of Investment Strategy
Quarterly Outlook
Head of Commodity Strategy
Quarterly Outlook
Global Head of Macro Strategy
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Head of Commodity Strategy
Quarterly Outlook
Global Head of Macro Strategy
Quarterly Outlook
Head of Fixed Income Strategy