The UK budget impact on the cost of debt – a week of volatility
Real Estate | London
Despite much of the UK budget decisions being leaked in advance of the Chancellor’s delivery, his announcements on borrowing forecasts and underlying growth assumptions sent the gilt and swap market into a tailspin. This short piece highlights some of the key movements and implications for UK borrowers.
Gilts market update
Following the budget announcement, the gilt market rallied substantially. This reflected lower borrowing forecasts from the OBR which led to sharp rises in gilt prices, particularly at longer-tenors. Investors had been expecting greater supply in the market pre-budget, but the improved fiscal outlook reduces the borrowing need. The government’s requirement for debt is predicted to drop by £34.7B this year alone, with £51.6B less needed in 2022.
The sharp drop in yields extended into the belly of curve where the 15-year gilt yield fell 12.0 bps to 1.168% with the 10-year gilt trimming 9.7 bps to end the day trading at 1.013%, their biggest one day drops since the current quantitative easing programme began.
At the short end of the curve the drops were less sharp, but their presence notable in an environment where short-term inflationary pressures continue to cause concern.
Lower rates and higher inflation have pushed real interest rates further into negative territory. The 30-year real yield is around its lowest level since 2016 at -2.02%. Should inflation spike further over the course of 2022 there is potential for this to drop lower still.
These inflationary concerns and market volatility also impacted the swap market, with the short end showing large increases in interest rates over the last month. Using the 3-year swap as a indication, the rate has moved from 0.599% to 1.072% in the space of one month. Cap premiums which are increasing also have the additional pricing impact of materially higher volatilities. A cap on £20M at a strike of 1.5% for 3 years was £75K a month ago, and today it is £192K.
Those borrowers with transactions to hedge in the last week have been faced with ever increasing funding costs; and that’s assuming their counterparty bank would even offer a price. We saw a few banks this week refuse to quote as they could not offset their own risk in such choppy conditions.
ChathamRates can keep you up to date on these market movements, but as always if you would like something specific priced, or to understand more about what is driving these movements your Chatham relationship manager can help.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.21-0303
Our featured insights
Q4 2022 Business Plan Assumptions
Chatham’s social housing team set out below its Q4 2022 business plan assumptions for housing associations and an accompanying economic commentary. Following a tumultuous third quarter in the Sterling markets, a new government and reverse of the “mini” budget induced a much-needed calm after the...
The hairy chart: Historical accuracy of LIBOR forward curves
These hairy chart graphs plot past LIBOR forward curves against the actual path LIBOR followed, showing that the forward curve has been a somewhat accurate predictor over the next six months or so...
The ECB holds firm while the BoE wavers
On 15 December, the European Central Bank (ECB) voted for a further 0.5% interest rate increase as the central bank continues its policy of monetary tightening in the face of high inflation. The bank slightly slowed the pace of increases (from 0.75% previously) as signs of a softening inflation...
A downshift in hikes but more to come in 2023
On Wednesday, December 14, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds target range by 50 basis points to 4.25–4.50%. This rate hike is guided by their long-term dual mandate of price stability while simultaneously ensuring maximum employment. The Fed is...
The first 75 bps hike from the Bank of England in 33-years in a split vote
On 3 November, the Bank of England (BoE) voted seven-to-two to raise the U.K. base rate by 0.75% to 3.00%, the two dissenters voting instead for hikes of 0.25% and 0.50%. The BoE Governor, Andrew Bailey, voted for the 0.75% hike while pointing to a slowdown in the pace of future hikes. This move...
Inflation persists despite historically fast hikes
On Wednesday, November 2, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds target range by 75 basis points to 3.75–4.00%. This rate hike is guided by their long-term dual mandate of price stability and simultaneously ensuring maximum employment. The Fed is...
Video Q&A with NYU's Dr. Sam Chandan
Matt Henry, Chatham's Managing Partner and CEO, sat down with Dr. Sam Chandan, Director of the Center for Real Estate Finance at the NYU Stern School of Business and founder of Chandan Economics, a leading provider of economic advisory and data science services to commercial real estate...
“Springing” interest rate cap requirements in CRE loans
“Springing” interest rate caps are a type of loan requirement that requires a CRE borrower to purchase an interest rate cap post loan closing if (and only if) the base rate for a floating-rate loan (like SOFR) crosses a certain threshold (often called the “trigger”). This structure permits the...