UK Rates Strategy: Fading the remaining tightening via SFI M7/M8 Steepeners

Research evidence excerpt

UK Rates Strategy: Fading the remaining tightening via SFI M7/M8 Steepeners

IdeaMunwound sharply while the market priced a full US/Iran de-escalation. At the same time,

the BoE and other central banks have continued to signal that inflation risks have not fully

faded, while front-end rates have continued to price some tightening premium. Finally, the

June FOMC triggered a hawkish market reaction, pushing real yields higher and

breakevens lower across the board.

For the UK front end, we believe last week’s comments from BoE Governor Andrew Bailey

at the ECB Forum on Central Banking in Sintra support fading the remaining tightening

premium. Bailey said the decision not to raise rates was based on a “softening economy”,

while also noting that “rate cuts are off the table at the moment” and that the MPC would

“return to it in July.”

We read this as marginally dovish for the front end: not a clear easing signal, but a shift

away from the risk of near-term hikes which could eventually lead toward a more

balanced discussion around the timing of eventual cuts. As such, we think it is now time to

fade the remaining tightening embedded in front-end rates by initiating an SFI M7/M8

steepener at around -4bp, with a target of +12bp and a stop loss at -12bp. The key risks to

the trade are a more hawkish shift in central-bank communication and a renewed repricing

of front-loaded hike risk.

The rationale is twofold. First, we expect a gradual dovish shift in BoE communication to

further compress near-term hiking expectations. Second, this should re-steepen the curve

as a dovish shift from central banks should push any additional term premium further out

the curve, making money-market steepeners an attractive way to play further

normalisation.