The UK rates market continues to mirror its transatlantic counterpart, with the Bank of England (BoE) pricing staying buoyed by shifts in the Federal Open Market Committee (FOMC) landscape. Recent Fed rhetoric has poured cold water on expectations of sustained rate cuts, leaving front-end pricing for the BoE relatively unchanged despite directional nudges from flows.
Front-End Moves: A Tether to the Back End
In recent sessions, flows have leaned toward receiving in December and February MPC contracts, though price action remains subdued. Even as markets rallied, any movement was driven more by the back end, amplified by comments from BoE’s Catherine Mann, who signaled a willingness for “more forceful” action should inflation demand it. Meanwhile, Friday’s underwhelming UK GDP data failed to sway rates, with US developments—like Fed Chair Powell’s Thursday remarks—holding sway.
The next litmus test for front-end UK pricing? The November 20 CPI print. While EUR markets have shown a capacity to decouple recently, the GBP market awaits its opportunity to do the same.
Flatteners in Focus
The desk’s favored flatteners—such as June/Aug MPC and m5 vs. h6 SFI—have delivered modest returns. We recommend maintaining these positions alongside protective steepeners like z4m5, which balance well for a neutral outright stance.
Flows continue to favor flatteners, with little appetite for steepening short-term rates within the current ranges. Given this dynamic, UK flattening is likely to evolve as a slow, steady grind unless there’s a sharp front-end repricing event.
Year-End Turn: GBP Under Pressure
This week saw a surprising turn in GBP dynamics as year-end pressures eased despite significant moves in the cross-currency basis curve. Historically, year-end turns with upward pressure on GBP would have been met with skepticism, but this time around, pricing for the December MPC and elevated sell/buy levels led to increased sell/buy flows from hedgers in the 2-3m segment. This activity erased previous highs of +20bp, dragging the turn back to 0bp and sending FX-OIS into negative territory for ex-turn periods.
Lower funding levels added fuel to the move, though we expect funding pressures to recover as GSE USD cash injections come online in the days ahead. Month-end dynamics may add temporary downward pressure, but we recommend scaling back received positions in this context. A funding bounce and limited catalysts make further significant GBP downside unlikely.
Long-End Cross Currency Basis: GBP’s Role
GBP has played its part in driving the well-publicized increase in long-end cross-currency basis, with levels turning positive out to five years. Notably, EURGBP basis widened by approximately 3bp at the 5y point amid a wave of offers.
While outright long-end dislocations may persist, the 1y1y cross-currency basis appears range-bound for now. Continued funding-related interest to receive in the 1y space adds support to this stability.
Takeaway
As the UK rates market stays tethered to US dynamics, key data like the November 20 CPI print will test whether GBP front-end pricing can chart its own course. Flatteners remain the desk’s preferred strategy, and year-end turn dynamics—though temporarily softer—are expected to stabilize. Stay tuned for a slow grind in UK flattening and continued shifts in cross-currency basis trends.
Disclaimer: This post is for informational purposes only and does not constitute financial advice. Market dynamics and recommendations are subject to change.
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