A Constructive Near-Term Outlook for UK Duration

Research evidence excerpt

A Constructive Near-Term Outlook for UK Duration

IdeaM

Interest Rate Strategy

United Kingdom | A Constructive Near-Term Outlook for UK

Duration

Our positioning

Positioning-wise, we keep our bullish front-end exposure via receiving the

September MPC and holding SFI M7/M8 steepeners, as valuations continue to

embed a high degree of tightening and an elevated risk premium. We thus remain

positioned for lower trough/terminal rates and money-market curve normalization.

Further out, we closed our 10s20s SONIA steepeners while keeping our

5y5y/10y5y forward steepeners. Over the past week, geopolitical headlines have

provoked some bear-flattening, while the latest Japan-related headlines might

reduce global steepening pressures. We thus believe that some reduction in

steepener exposure makes sense here, as the near-term domestic backdrop might

also prove positive for UK duration, cross-market valuations and swap spreads.

As such, we switch our 5s10s ASW box flattener into a long 10y ASW. The FSR’s

proposed leverage-ratio changes remain supportive of front-end spreads, but the

market reaction was disappointing relative to our expectations. In the near term,

we see growing risks of a steepening in the ASW curve, as the domestic backdrop

should turn more supportive over the summer period. Finally, we took some profit

on our long 2y3y breakeven position following the recent upward repricing of

energy prices.

Geopolitical developments took centre stage over the past week. Although the market

impact proved short-lived, the episode served as a reminder that the backdrop remains

uncertain and that volatility could return quickly, challenging outright long and carry

positions.

At current valuations, around 35bp of hikes are priced by the April fixing (see Exhibit 1 ),