Divyang Shah, Senior IFR Strategist
This will help to shift from playing the extremes but the overall trend is at this stage likely to be one of generally higher yields as the UK finds it difficult to divorce itself from what is happening in the US.
In June we went from paying 2y1y GBP to receiving 1y1y GBP as we felt that the market had gone far enough in pricing Fed tapering related contagion.
The rationale received additional help from our view that the BoE would surprise and deliver a statement which it duly did with forward guidance. With 1y1y GBP at 0.845% we look to take profit on the 1y1y GBP receiver making 25.5bp profit as the trade was initiated at 1.10%.
A chart of 1y1y GBP shows that it is at the upper end of the range from Q4 2012 until May/June 2013.
It seems attractive now to play for a re-steepening of the money market curve based on BoE’s forward guidance being less effective in the face of upside on both real sector data as well as inflation.
It won’t be until August when we get the next phase of a more formal forward guidance script from the BoE but until then we also have Bernanke’s semi-annual testimony next week to get through.
Having closed the receiving on 1y1y GBP we will go the other way and pay 1y1y GBP at 0.845%. The clear risk is that the Fed will manage to get its own communication under control and markets in general will see money market curves flatten further but at this stage we don’t see this happening.
The Fed does not want to muddy its own tapering script in order to allow market rate expectations to adjust
