The 12x24 EONIA and SONIA forwards are down some 2/3bp, with the former trading around 42bp and the latter just above 70bp. While the BoE MPC members looked to stay on message with the forward guidance at the TSC meeting last week, we had Draghi look to add “unwarranted” in order to strengthen the ECB’s forward guidance.
The market reaction to weak US data highlights how instead of words, the more important factor at work on the money market curves remains what happens with sentiment toward the US. In this context, the FOMC meeting will be key, and our belief remains that instead of tapering, the thing to focus on is how the Fed looks to strengthen its forward guidance.
There are two avenues through which the Fed can look to adjust market expectations:
1) providing a lower bound for inflation at 1.5% as well as an upper bound, and
2) reducing the unemployment threshold to 6% from 6.5%
This should allow money market curves to flatten further, although on 12x24 EONIA we think that downside will be limited to 0.35%, while on 12x24 SONIA there is scope for a move back to 0.60%.
But our preference has been to look to receive 1y1y GBP instead from 1.165% last week (currently 1.08%) with a target of 1.05%.
We will look to take 50% off the table at 1.05%, and let the rest run with a tight stop at 1.10%
