"This Looks Like An Absolute Disaster": UK Short-Term Yields Blow Up Most Since 2010 As Frantic Traders Front-Run BOE Rate Hikes

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by Tyler Durden
Monday, Oct 18, 2021 - 12:45 PM

Frantic rates traders pulled forward rate-hike bets after BoE governor Bailey said over the weekend that the central bank “will have to act” on inflation. The move manifested in a huge spike in 2Y gilts, which rose as much as 17bps to 0.75%...

... the biggest one-day move since 2010, before easing a bit. Even more striking, 3-month sterling LIBOR soared by 7.9bps, the biggest one day surge since Lehman.

On Sunday, BOE Governor Bailey said inflation “will last longer and it will of course get into the annual numbers for longer as a consequence… That raises for central banks the fear and concern of embedded expectations. That’s why we, at the Bank of England have signalled, and this is another signal, that we will have to act. But of course that action comes in our monetary policy meetings.” As DB notes, it’s difficult to get much more explicit than this.

Besides the usual, and now daily, surge in commodities, a Friday report from Goldman also predicted the BOE would likely raise rates in November, pouring fuel on the rate hike frenzy.

“While we view it as a close call between a November and December lift-off, we think the November meeting is slightly more likely given it comes with a press conference and updated projections within the Monetary Policy Report,” Goldman Sachs economists wrote adding that they now expect 3 rate hikes at alternate MPC meetings, taking BOE’s benchmark rate to 0.75% by May, and 1% by the end of next year.

Not surprisingly, UK money markets reacted accordingly, and now see 36 basis points of BoE rate increases in December, while pricing 20 basis points of tightening next month. Traders are also now betting the BoE’s key rate will top 1% by August, an even more aggressive timeline than Goldman's, from 0.1% currently.

Commenting on today's move, Bloomberg's Michael Read writes that "this morning’s move in gilts and short sterling is quite something. We are now cheaper by 13-16 basis points across the short end, with white and red pack sterling off as much as 20 ticks. 2y gilt yields are set for the biggest intraday move since 2010. It reeks of some sort of capitulation with legacy long/dip buyers throwing in the towel after Bailey’s weekend comments" even though as the BBG commentator notes, "once again, perhaps oddly, the pound is completely uninterested in the rates ruckus."

That said, Read is less convinced an imminent rate hike is on deck: "I think it’s fair to say that the level of conviction in the U.K. rates space is unprecedented. However, just because Bailey said something does not guarantee that it will happen. One could argue that a near term hike vote from Saunders, Ramsden, Broadbent and Bailey might be in the bag; Huw Pill’s TSC questionnaire was decidedly balanced and Tenreyro/Mann do not sound like dissenters as yet. Worth flagging that while we are due to hear from several BOE policymakers this week A near term move, to the scale reflected by OIS rates, with a fractured MPC would be remarkable. While there appears to be a growing contingent flagging the potential for a policy error. Today’s price action seems to suggest the market just doesn’t care."

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Whether or not a hike comes, however, there are those who are already bashing the development, none more so than former Bank of England policy maker Danny Blanchflower (who last weekend suggested that the US is already in a recession), who said that lifting U.K. interest rates anytime soon would be “a terrible error.”

“I think they may go and do that, but it would be a very foolish thing to do, especially with what the data is doing and the chancellor is doing, but also the possibility and this is a distinct possibility that the U.S. is going into recession,” Blanchflower said on BBC Radio 4’s “Today” program on Monday quoted by Bloomberg.

“These seem very early days to be thinking that. The economy is very hard to understand right now. It looks to me as with every interest rate rise since 2008 that they have all been in error” he said, adding that “there’s lots of things to think about. We’ve just had a big furlough scheme, which means the labor market is very difficult to understand. We’ve had a very little bit of inflation. It looks terribly temporary”

“Think of an island if a hurricane hits it. The price of plumbers and roofers is going to rise. Once the adjustment takes place those prices are going to fall. These paths, these changes in inflation look to be enormously temporary. And any response by the central bank to those changes look to be a big error. It looks increasingly like 2008.

His conclusion is probably not wrong: If the BOE raises rates now, “They’d probably have to reverse it quite quickly.” In fact, that may be just what central bankers are hoping for: to hike into a recession so they have justification to cut right after.

“This looks like an absolute disaster if the Bank of England did it. This looks like a terrible error.”

Maybe, but tell that to those who are about to spend a quarter of their paycheck on heating bills and gasoline.