Gilts Have a Ticket to Ride, Just Where Is Still the Question

(Bloomberg) -- The no-deal Brexit tail risk will dictate the direction of travel for gilt yields with focus now on the length of any Article 50 extension. Small sell-off comes from Parliament moving toward taking control of the process, opening up a softer outcome.

It is likely the market will remain a range-bound prisoner as the failure of May’s deal just adds to the uncertainty rather than presenting a decisive moment to re-price. Interest rate volatility isn’t pricing any aggressive jump risk for yields amid this week’s Brexit votes. The Spring Statement will deliver a new gilt remit Wednesday with the skew of DMO issuance potentially driving some relative value plays.

• The defeat of May’s deal by 149 votes increases the likelihood of a different approach being needed rather than trying to re-flog a dead horse
• The length of any extension to the Brexit deadline is key; postponing by three months will unlikely be a game changer given that no-deal risk would be just pushed slightly out and would not be particularly bearish for gilts relative to a much larger extension
• In the event of any sell-off, real rates will lead given the richness in inflation markets, which are elevated relative to falling expectations elsewhere and due to the liquidity risk associated with no-deal for outright shorts; however, the weak data trend would keep the sell-off contained

• Spring Statement and DMO’s new gilt remit is in the mix on Wednesday, with the split of planned issuance across the gilt curve and linkers the main focus
• The outperformance of the three eligible bonds for the BOE to buy in the 7y-15y bucket may see some unwind if the DMO skews a greater amount of issuance in that part of the curve, and long-end breakevens may outperform if linker issuance is reduced more than expected; curveball for inflation markets will be on any government announcement on the future of RPI
• See analysis here from Feb. 7 on the micro-RV switches between outperformance of low-coupon bonds in this bucket; these are the only BOE eligible bonds in this sector given the 70% issue-limit constraint reached on the high-coupon gilts
• NOTE: Tanvir Sandhu is a global interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Tanvir Sandhu in London at tsandhu17@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Scott Hamilton

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