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Summary
- UK gilt yields have risen across the curve in the past two weeks.
- Bank of England (BoE) Governor Andrew Bailey downplayed any inflation rise, instead focusing on the UK’s weak growth environment and accelerating disinflation.
- Momentum players have increased UK gilts bearishness.
Market Implications
- We think the rise in gilt yields presents an opportunity to scale into longs, and we like to buy further price dips in gilts.
Gilt Yields Have Risen Across the Curve This Month
UK yields have risen from year-to-date (YTD) lows two weeks ago. We think this represents a buying opportunity.
2-Year Gilts
On a closing basis, the 2-year gilt yield printed a YTD low on 10 February, now trading about 12bp higher (Chart 1).
10-Year Gilts
Meanwhile, the 10-year gilt yield printed a YTD low on 10 February, now trading about 15bp higher (Chart 2).
Bailey Downplays Inflation Threat
On Tuesday, Bailey downplayed the threat of a resurgence of UK inflation.
Bailey acknowledged that inflation will rise in the short-term, but far from levels seen a few years ago.
Bailey instead emphasised that disinflation has accelerated more than the BoE expected.
Moreover, Bailey highlighted the UK’s ‘weak growth environment.’
This Week’s Data Lifted Gilt Yields
Data has mainly driven the gilt yields uptick across the curve this week, despite Bailey’s dovish lean.
On Tuesday, average weekly earnings for December rose MoM, with the magnitude of the rise. Employment also rose more than expected.
And Wednesday’s headline and core January CPI rose MoM, with headline exceeding consensus expectations.
Today’s retail sales also surprised to the upside, with food purchases a key driver.
As a result, gilt yields have risen across the curve.
Momentum Players Ratcheted Up Gilt Shorts
Partly due to stronger data and attendant price action, momentum players have cranked up gilt shorts in the past week.
CTA net signals are very bearish after being modestly bearish last week (Chart 3).
This could be an early signal that short positioning in gilts is crowding.
The longer this continues, the higher the probability short positioning becomes stale and experiences a short squeeze.
Time to Scale Into Longs – Buy Dips
We think this uptick in gilt yields represents an opportunity to build a long position.
Given this week’s stronger inflation data, we think the BoE will probably look through the drivers (food and rents). Bailey’s comments support this.
Although short positioning is not yet crowded, we caution the CTA positioning shift as a precursor to short gilt exposures becoming stretched.
Therefore, we scale into shorts from current levels, and like buying dips.