UK Bonds Poised for Winning Week as Traders Trim BOE Hike Bets

The UK was the main beneficiary of a repricing in global bond markets that followed dismal business activity data in the world’s major economies.

(Bloomberg) — The UK was the main beneficiary of a repricing in global bond markets that followed dismal business activity data in the world’s major economies. 

Gilts were poised for their best week in five months as traders trimmed bets on further Bank of England interest-rate hikes following disappointing PMI readings. The UK’s 10-year bond yield fell 22 basis points in five days, the most for a week since March and more than all its developed-nation peers.

While Treasuries and other European bonds also gained earlier in the week as US and euro-area data failed to meet expectations, the room for adjustment was bigger in the UK. Before the data, the base-case scenario implied in swaps tied to the central banks meetings was for three more rate hikes by the Bank of England, compared to just one from the European Central Bank and possibly none from the Federal Reserve.

“This week, everything turned around,” said Richard McGuire, a rates strategist at Rabobank, who sees recession risk moving back toward the center of markets’ radar. “We have been and remain bullish.”

The UK’s private-sector firms suffered their first contraction in seven months in August, revealing the growing economic toll of higher interest rates and the squeeze on households. PMI figures for the euro area also showed a contraction in private-sector activity, while business activity in the US barely expanded due to sluggish demand.

Money markets pared bets on further interest-rate hikes in the UK and now see 65 basis points in additional tightening, compared to 80 basis points by the end of last week. That would bring the BOE key rate to 5.9%. 

Traders are also now pricing in less tightening by the ECB, with about 16 basis points of further hikes expected versus about 20 basis points last Friday. Bets on Fed peak rates, however, have increased by five basis points this week.

The deteriorating economic outlook in the UK “could lead to a less hawkish monetary policy than investors are currently foreseeing, and therefore to a further gilt rally,” said Francesco Maria di Bella, a strategist at UniCredit Bank AG.

More negative economic data will cause gilts to rally and yields to fall, said Dan Boardman-Weston, CEO and chief investment officer at BRI Wealth Management. A yield above 4% “feels like value over a medium-long term investment horizon.”

Investors will look for more clues on the central banks’ trajectory at the Kansas City Fed’s Jackson Hole Symposium, where Fed Chairman Jerome Powell, ECB President Christine Lagarde and BOE Deputy Governor Ben Broadbent are due to speak.

Next Week

  • UK debt stands to benefit from an absence of bond sales next week, alleviating pressure on yields which would otherwise tend to rise to make room for the supply
  • In contrast, euro-area nations are set to sell up to €13 billion of bonds next week according to Commerzbank AG, with Germany, Italy and Belgium due to hold auctions
    • Syndications may also pick up after the summer lull, following Finland’s €3 billion five-year bond sold on Aug. 23
  • Provisional inflation readings for August are among the euro area’s key releases next week, with the figure for the whole bloc due Thursday
    • The year-on-year headline measure is expected to drop to 5.1% from 5.3%, according to a Bloomberg survey; core measure seen dropping to 5.3% from 5.5%

–With assistance from Alice Gledhill and James Hirai.

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