Have a care, spread traders .... poor UK numbers may just undermine plans for the Carney - Yellen Spread
Wednesday 9th September 2015
Ref : "Carney - Yellen Spread Suggests Investors Misreading
Chances of a UK Rate Hike" , Bloomberg Markets Online
Ref : "UK Factory Output, Export Slump Give BoE Reasons for
Caution" , Bloomberg Markets Online
First, some background ..... the Carney - Yellen Spread, so
imaginatively named after the bosses of the UK and US central banks, refers to
the tradeable differential in yields on the government bonds of the
two nations, in particular in the 10-year maturities. So, at the time of
writing the UK's 10yr Gilts yield 1.86% whilst 10yr US Treasuries yield 2.22%,
a differential (spread) of 36 basis points.
Always remembering that yields move inversely to prices, some
major houses have been suggesting that the yield spread is too wide.... or in
price terms, that UK Gilts are too expensive relative to US Treasuries.
The advice then has been : Sell Gilts, Buy Treasuries in the expectation that
the yield spread will narrow to 15 basis points or less. They argue that
although BoE Governor has made it plain the higher UK rates will have to come
into focus by the turn of the year, futures markets have not fully priced
in a rate hike until October 2016. More generally, they suggest that while
markets have been fully focused on the forthcoming US rate rise (haven't they just?),
they've been underestimating the BoE's willingness to begin the tightening
process.
It's a cogent argument, but sounded a lot better before the
release of UK data this morning. Industrial Production fell 0.4% in July (it
was expected to rise 0.1%). The news follows disappointing factory
and services data last week, and was accompanied by a slump in exports that saw
the trade deficit widen to its largest this year. The BoE announce their
latest decision on rates tomorrow, along with the minutes of the policy
meeting. It would be fair to say that all things being equal this recent
stuttering in the UK economy hardly demands a rate hike, and with the trade gap
in mind the probable extra strength it would give to sterling would be most
unwelcome.
Not that anybody has been expecting a rate increase tomorrow.
Rather, they'll be waiting for the minutes of discussions to see if any more
than one of the 9 committee members voted for a move. Global market turmoil and
the these recent numbers would seem to mitigate against it, at least for now,
and those betting on a narrowing of the Carney - Yellen Spread may have to be
patient too.
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