UK still holds the best macro trades around - TDS

Richard Kelly, Head of Global Strategy at TD Securities, suggests that even lower gilt yields and weaker GBP are coming as macro is in the driver’s seat in the UK.

Key Quotes

“So for UK easing trades, in rates we remain long Sep 16 short sterling to 99.82, received 2y GBPUSD basis swaps to -25bps, in Sep 16 FRA-OIS wideners to 27bps, and short GBPUSD into the 1.20-1.25 range. As QE expectations are priced in—and potentially even begun by the BoE—over the next month, we would expect gilt-UST spreads to be stretched enough to argue for  x-cty spread tighteners.  But for now, outright directional UK trades offer some of the best risk-reward around.

Whether 10y gilts or GBPUSD, they are taking all of their direction from the ultimate destination for Bank Rate, which we think is 0.00%. There is a small risk the BoE decides to call 5-10bps the lower bound, but this differentiation is inconsequential. Assuming limited market stress manifesting itself in FRA-OIS, that implies short sterling prices to around 99.90, equivalent with 10y gilts at just 50bps – unconscionable not long ago but 100% justified by policy outcomes – and GBPUSD into the 1.20-1.25 range. And that is all without pricing in any implications from QE.

With just three weeks separating the 14 July BoE meeting from its subsequent one where the full, updated post-Brexit forecasts with press conference will be presented, there are big risks around the precise timing of when all of this is communicated vs delivered. In the grand scheme of things, easing in July vs August amounts to a hill of beans. But we have a high conviction it will be delivered. While we’ve yet to have Q2 UK GDP, the range of reasonable expectations for Q3 GDP with the data on hand is currently –0.2 to –1.0% Q/ Q (not annualized). The status quo will justify immediate action from the BoE this summer.

This does provide idiosyncratic UK trades as it breaks away from global macro trends. While the nice relationship between UK rate expectations and oil—the gauge of when inflation was likely to allow BoE hikes—has broken down, it provides a rough gauge of what global markets would look like if the global economy were about to suffer as much as the UK—oil prices below $20. For now, markets will be able to fade spillover risks, with lower real yields putting a floor in risky assets. Ultimately, we need to see the full extent of economic contagion before markets can feel comfortable.”