Traders betting directly against interest-rate hikes by the Bank of England do so at their peril — no matter how overblown market pricing might look.
(Bloomberg) — Traders betting directly against interest-rate hikes by the Bank of England do so at their peril — no matter how overblown market pricing might look.
With the BOE’s latest decision due in days, banks including HSBC Holdings and Citigroup Inc. are telling clients that the scale of tightening currently baked in to money markets is too aggressive. At the same time, with sticky inflation putting pressure on shorter-maturity notes and volatility high, they warn the timing of any policy shift is far from certain.
“We find ourselves frustratingly at the mercy of timing,” said Daniela Russell, a strategist at HSBC. “The front-end remains exposed to hawkish surprises, making it too early to buy outright.”
For the past 18 months, predictions that the UK economy will buckle under the BOE’s run of aggressive hikes have failed to materialize.
By November, borrowing costs in the UK will be higher than in the US and will remain there for decades, according to market pricing, potentially the first prolonged period they’ve swapped places since before the 2016 Brexit referendum.
According to Russell, the paths of the Fed and the BOE should be more closely aligned.
“While we acknowledge the risk of more tightening in the near term, we ultimately do not think the BOE will keep monetary policy as restrictive as markets are currently pricing,” she said.
Interest-rate markets assume a single, quarter-point increase on Thursday, followed by at least one more — or possibly two — by September. That would bring the key rate to 5% for the first time since 2008. Economists, meanwhile, expect a lone hike of 25 basis points.
Steepeners
Russell and others recommend so-called steepener trades — which involve betting on the difference between the yields on short- and long-maturity gilts, and which pay out when the yield on longer bonds rises faster.
That’s a less direct way to bet on future rate cuts than simply buying the shorter notes, which are volatile and can leave an investor exposed to sharp losses should the BOE once again prove more hawkish.
Investors looking to wager on lower rates should also look at the difference between UK 10- and 30-year yields, which reacts to moves in shorter maturity gilts when measured over six months, Citigroup strategists said. That makes steepeners between those two maturities a “cautious” and “indirect” way to bet that front-end rates will eventually fall, they said.
“Our bias is to fade peak pricing” but doing so “outright” is hard to time, Citigroup fixed income strategist Jamie Searle said. The next round of inflation and wages data “could again lean hawkish.”
Another way to position is via US markets, said Imogen Bachra, head of UK rates strategy at NatWest Markets. She suggests a cross-market trade betting UK front-end rates will converge with their US counterparts.
Fragile Bets
To be sure, more bad news from the US banking industry could scupper that bet. A surge in wagers that the Federal Reserve would be forced to pivot to rate cuts early spoiled Citi’s similar cross-market trade a week before last.
And traders might need a clearer dovish signal from BOE officials for prices to shift meaningfully.
After all, money-market traders have consistently predicted tighter policy than economists this cycle. They’ve largely been proved right — those who bet against hawkish pricing were burned even before the BOE started hiking in 2021.
Antoine Bouvet, head of European rates strategy at ING, says sterling rates may trade higher than their US equivalents “for some time, until the market gains conviction that the BOE will follow the Fed in its cutting cycle.”
“The BOE remaining non-commital on its next policy steps should not cause an immediate retracement.”
–With assistance from James Hirai and Aline Oyamada.
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