Over the last few weeks the UK’s first post-Brexit vote economic data releases have smashed expectations, but gilt yields have pushed lower regardless. It’s still early days, but if things continue this way, gilts “could be vulnerable to a mild correction”, according to Citi.
Amid the post-referendum gloom that descended on the UK, economists slashed their forecasts and gilt yields plunged as markets priced in a Bank of England rate cut.
But so far UK economic data haven’t deteriorated as anticipated, writes Joel Lewin.
A slew of key data points in recent weeks have topped economists’ forecasts, including retail sales, GDP, mortgage approvals, unemployment and CPI.
Citi’s economic surprise index, which tracks how data compare with economists’ forecasts, has rocketed to a three-year high.
Gilt yields have typically tracked this index, rising when data is surprisingly good, and sinking when the economy is unexpectedly bad. (Yields rise when prices fall.)
But as Jamie Searle at Citi points out, right now gilts are ignoring the data.
For now, he says that’s fair enough, because “the recent data tells us almost nothing about the long-term prospects for the UK amidst Brexit uncertainty” and “the market is right to price a very, very distant hiking cycle”.
Mr Searle says that although the data have been better than expected, they do reflect a slowdown. And moreover, he says:
Gilts have become desensitised to economic surprises over the last couple of years. The market is trading central bank policy – with the MPC having just struck its sledgehammer package – making data surprises less relevant.
But even so, a bounce in business and consumer surveys could lessen the chance of another rate cut, a move that the market has already thoroughly priced in. Mr Searle says “this is the most significant near-term bearish risk facing gilts.”
If the data starts to challenge the policy outlook – in particular the prospect of another rate cut this year – then gilts could be vulnerable to a mild correction
Next week’s spate of business/consumer surveys are particularly significant and could be pivotal to near-term direction.
However, if this correction does materialise, it is likely to affect only short and mid-term gilts, says Mr Searle, with long-term gilts protected by the high structural demand that has made the Bank of England’s long-term gilt purchases such a challenge so far. “Here, weekly QE purchases, light near-term supply, and reluctant sellers of gilts are likely to prevent a sell-off (implying more flattening),” says Mr Searle.
On the other hand, two- to 10-year gilt yields could be hit by a correction of 10bps, he says.
Second chart courtesy of Bloomberg
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