U.K. Joins Global Bond ‘Steam Train’ in Bets on BOE Rate Cut

(Bloomberg) -- The U.K. is catching up with global bond gains as investors bet the Bank of England will be forced to follow peers in signaling rate cuts.

Money markets are now pricing in a full 25-basis-point cut by next August, following warnings about trade conflicts from BOE Governor Mark Carney and disappointing U.K. economic data. That is leading Banco Santander SA, JPMorgan Chase & Co. and UBS Group AG to see a steeper gilt yield curve as short-term bonds climb faster.

“Gilts were defying gravity towards the end of June and ignoring the ongoing rallies in the U.S. and euro zone,” said Adam Dent, a U.K. rates strategist at Santander. “This week the penny dropped and we snapped back. Long-term rates can stage a bit of a recovery in coming days as things settle down, but the very front end has a lot of scope to keep moving.”

While a stronger-than-expected U.S. jobs number on Friday took the shine off the past week's global bond rally, gilts still outperformed their German and U.S. equivalents. Ten-year yields dropped below the BOE's key rate two days before bunds did the same with the European Central Bank's deposit rate.

With more and more of Europe's debt joining a record global pile of negative-yielding debt, benchmark gilts still offer yield hunters 0.74%, more than double Spain. While European nations focus on the economic outlook and prospect for ECB stimulus, for gilt traders there is also a lot of political risk to weigh up.

The contest to elect the next prime minister is ongoing, with the result due on July 24, and then there's the Brexit deadline on Oct. 31. Front runner Boris Johnson has raised the prospect of leaving the European Union even without a withdrawal agreement with Brussels.

For Santander's Dent, short-term gilt yields are likely to continue lower given the acute shock looming over the U.K. if Britain does eventually leave the bloc without a deal. He sees 10-year gilts reversing some of their aggressive month-to-date rally next week, making a bet on a steeper curve between the two-year and 10-year an attractive play.

Even for those not convinced the U.K. rally has staying power, it takes a lot to bet against it right now. Gilts are too expensive given inflation and recent PMI data for Investec Asset Management portfolio manager Russell Silberston, but he is not shorting them.

“Our bias is to be underweight,” said Silberston. “However, we have not actually sold yet as it is like standing in front of a steam train. Global duration is on a rip.”

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net

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

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