NatWest: Cross-Market Underperformance Of Gilts Can Continue, Especially Vs Bunds

NatWest write “a relatively more hawkish central bank combined with a still heavy supply outlook, which weighs the most in the UK given the relative increase in supply compared to the size of the market and the shift in the appetite from traditionally natural buyers of gilts, leaves UK yields vulnerable to further cross-market underperformance, we think.”

• “This was one of our key trades when we wrote our Year Ahead, looking for a 35bp underperformance of 10y gilts vs 10y Treasuries.”
• “Since then, gilts have underperformed about two thirds of the way to that target. Whilst there is likely still further to go, we prefer to shift these cross-market shorts against bunds now.”
• “Bunds have outperformed gilts much less than Treasuries have in recent weeks, and there is scope for this to reverse as the ECB shifts to a more dovish outlook, signalling earlier cuts, justified by a much less sticky inflation backdrop.”
• “A more dovish ECB also helps supply to be better absorbed at the long-end of the Euro curve than in the UK.”
• “Near-term gilt underperformance vs bunds is supported by seasonals too. On an outright yield basis, February tends to be the worst month for gilts vs bunds, across the curve.”