Jack Di Lizia, Strategist at Deutsche Bank, suggests that an increased focus on Brexit risk has dominated front-end and currency moves, but further out the curve the underperformance of UK cash is likely also a result of duration indigestion now that February’s supply has come to an end.
“Front-end pricing seems excessive relative to news flow over the week. Instead, it seems the market is now pricing a dovish premium related to Brexit, with the Bank of England expected to err on the side of caution until clarity emerges over the result. We maintain our GBP FRA-OIS wideners vs. Europe.
The long end has underperformed both on the curve and against swaps, a result, in our view, of a duration overhang from February supply rather than Brexit concerns alone. From a more strategic perspective, however, the UKT 10s30s remains too flat against our model. We maintain our risk premium steepeners in the UK, which should benefit from increased Brexit risk together with the offsetting impact on inflation from the current FX weakness.
The 5Y point has richened over the past week, in excess of what could be explained by recent directionality. Anticipated re-investments from GBP 9bn of coupons which went ex-div this week are likely to have provided support. With cashflows now done and the 1.5% Jan 2021 due to be tapped on Wednesday, we would expect the 5Y point to cheapen. As a result, we recommend being tactically short 5Y on the UKT 2s5s10s fly.”
(Market News Provided by FXstreet)