Bullish Front-End and Spreads into a Key Week: UK Rates Strategy | Europe

Research evidence excerpt

Bullish Front-End and Spreads into a Key Week: UK Rates Strategy | Europe

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Money markets continue to price in around two hikes by the April MPC meeting ( Exhibit

1 ). Over the past week, July MPC pricing reached roughly 6bp of tightening, while

September briefly priced a full hike intraday. We think this reaction was overdone,

particularly in terms of the front-loading of tightening expectations.

Geopolitical developments remain central to central-bank reaction functions. However,

even in a more adverse scenario in which energy prices rise further, we would still expect

the MPC to proceed cautiously over at least the next couple of meetings. A moderation in

near-term hike expectations should mechanically re-steepen the money-market curve. We

therefore continue to receive September MPC and remain in M7/M8 money-market

steepeners.

Further out the curve, front-end forwards moved broadly in line with EUR over the past

week, while the US outperformed materially following softer-than-expected CPI data

( Exhibit 2 ). The UK curve bear-flattened, as expected, in response to the aggressive front-

end repricing. Considering the extent to which the front end has already repriced higher,

we now see limited scope for further bear flattening and maintain our 5y5y/10y5y

steepener.

Exhibit 1: MPC cumulative tightening priced by meeting Exhibit 2: Weekly changes in selected G3 forward rates

bp bp

60 15

49.8

50 47.2

41.5

40 35.3

30 26.1

13.5

10 -5

2.0

Jul Sep Nov Dec Feb Mar Apr

GBP USD EUR

Cumulative

Source: Bloomberg, Morgan Stanley Research

Given renewed geopolitical tensions, we compare current Brent crude and UK natural gas

futures prices with the BoE’s conditioning paths under Scenarios A, B and C in the April

MPR.