Long-dated gilt yields surge, bond market braces for more volatility

Market update

Economic news

• Monthly GDP is estimated to have grown 0.20% in August, following a contraction of 0.60% in July.
• The July contraction was primarily driven by a decline in services output, but this recovered in August, with the services sector making an upward contribution of 0.30%.
• Economists believe — while the U.K. has so far skirted a recession — it may have entered one in the third quarter. This view is supported by weak retail sales and purchasing manager index (PMI) readings in September and preliminary readings for October, which were both contractionary.
• Average pay (excluding bonuses) grew 7.80% in the three months to August, from 7.90% in the prior period. Average total pay growth (including bonuses) was 8.10%, slightly below consensus of 8.30%.
• Employment data also indicated cooling labour demand with both a continued downward trend in job vacancies and number of payrolled employees. Unemployment rose to 4.20% between June and August, up from 4.00% in March to May.
• Headline September CPI was unchanged at 6.70% compared to the consensus of 6.60%. Easing prices in food and goods were partly offset by rising motor fuel prices and other categories including restaurants and hotels.
• Core and services inflation, a key metric for the Bank of England (BoE) MPC, came in higher than the consensus, prompting concern about underlying long-term price pressures.
• A drop in October headline CPI is expected due to an energy price cap reduction from Ofgem and more favourable year-over-year price comparisons.
• Retail sales fell 0.90%, contrasting the 0.20% decline forecasted by economists. The poor performance was largely attributed to weak clothing sales due to unusually warm weather.

Sterling rates markets

• Gilt yields and SONIA rates are sitting at comparable levels compared to the last fortnight. However, there has been a lot of volatility in the long end of the curve at maturities 10-years and beyond.
• Gilt yields continue to sit at year-to-date highs, with the 30-year gilt sitting at +5.00%.
• While sitting at an elevated level, the same volatility hasn't shown in shorter tenors sub 10-years.

Scottish government bond

• The Scottish Government announced that it will issue bonds for the first time.
• The aim is to raise funding for infrastructure projects such as affordable housing and build credibility with investors.
• While the size of the initial issue has not been announced, the Scottish Government — under the existing framework — can raise £450M per year to a total of £3B.
• However, they would have to pay a premium over U.K. gilts.

Housing association spreads

• Spreads remain close to the tightest levels of this year.
• The relative movement between credit tiers emphasises the importance of maintaining a strong rating in the face of wider market concerns about the sector as a whole.
• Tier 1 and Tier 2 differentials have widened and Tier 2 and Tier 3 differentials have tightened.

Bank market

• Bank lenders remain relatively positive towards the sector across the various funding sources. However, there are growing concerns related to the credit quality and, in some cases, regulatory risks facing certain social landlords.
• There has been inconsistency across lenders as certain banks are quoting comparatively expensive indicative terms regardless of the strength of the credit.
• Whilst Chatham has seen high-quality, competitive offers on the five-year tenor for strong credits from certain lenders, others are widening margins regardless of the credit standing of the borrower.

Private placement market

• Illiquidity premium is widening and now at c. +30 bps among private placement investors. This is driven by macro-economic uncertainty and market sentiment as a whole.
• U.S. investors are pricing more competitively compared to U.K. investors for the sector.