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5-year swap spreads widen (but correction may not be imminent): (2/2)

GILTS
  • From a macro perspective, the 5-year swap rate is important as a large number of UK mortgages are 5-year fixes (with mortgage lenders basing their rates on swap rates). 5-year swap rates are now only 3bp or so lower than they were following the MPC's decision to keep rates on hold at the November meeting.
  • Since the November meeting, we have seen inflationary pressures increase (5-year breakevens based on gilts are around 10bp higher than heading into the meeting, meaning that 5-year nominal gilt yields have fallen around 20bp).
  • So what next? It seems as though the move in nominal gilt yields is vulnerable to a reversal, particularly when QE ends in five weeks time. In the interim there could be a bit further for swap spreads to go, but going into 2022 after QE ends and as gilt supply starts to pick up substantially again in April, it seems as though the medium-term direction for swap spreads will be tighter.
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