Sterling markets remain sensitive to US dynamics and risk pricing in a too dovish path of easing by the Bank of England. Any tweaks to the pace or composition of quantitative tightening would not solve the fiscal concerns that underlie the (global) rise in longer-dated rates. Meanwhile, Wednesday's US 10yr auction tailed. Not great! 30yr up next.

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The Bank of England cut is expected, but comments about QT going forward are of more interest

Markets are perfectly aligned with quarterly Bank of England (BoE) cuts, including Thursday’s widely expected cut, but we see risks of sterling rates getting too carried away by US dynamics. The bullish move in US rates on the back of payroll disappointments also reduced markets’ pricing for the BoE landing zone by about 10bp. Whilst we do argue that the BoE may still end up cutting more than currently priced, the still hot UK inflation dynamics do not warrant a more dovish view at the time being. As such, we favour fading US-driven spillovers on the front end of the sterling curve for now.

Of more interest may be comments about tweaking the path of quantitative tightening (QT) going forward, with the aim to relieve some of the upward pressure on the long end of the curve. The 30Y Gilt still trades at a yield close to the record high since 1998. To alleviate the supply side, the BoE could reduce the pace of QT, which until September stands at £100bn annually. With plenty of liquidity still in the system, another way of addressing the concerns is by shortening the maturity of the bonds that are being sold. Whilst we think such solutions could help in the near term, the fact remains that the UK faces serious fiscal challenges and upward pressures on longer rates are a global phenomenon. Any such tweaks would not address the more (global) structural challenges faced by Gilts.

US 10yr auction tails by 1bp – not good!

The big miss in the 10yr auction was lower direct bidding, essentially real money players. That was down at below 20% compared with closer to 24% in the past six months. Dealers had to take down some 16% vs a more typical 10% in the past six months. That's two tailed auctions in a row (after the 3yr on Tuesday), with the 30yr to come tomorrow. These tailed auctions certainly question appetite for yields at current levels, despite all of the supportive rate-cut talk.

Remember, when you see the 10yr at c.4.2%, you need to view this as really c.3.7%. Why? Because there is a 50bp swap spread to SOFR. 10yr SOFR at 3.7% is not that high when we consider that the market discount is for the funds rate to bottom at around 3%. Effectively that's a 70bp curve from the funds rate to 10yr SOFR – not particularly steep. So if wondering why not enough buyers at c.4.2% on the 10yr Treasury, that's part of the answer

Thursday’s events and market views

We start the day with German industrial production data, which consensus still sees shrinking year-on-year. Then we have the Bank of England meeting, for which markets price in 24bp of cuts, so practically a 100% probability. From the US we have jobless claims and wholesale inventories data.

In terms of issuance, we have Spain auctioning 3Y, 10Y and 18Y SPGBs together with a 5Y SPGBei for a total of €5.75bn. From France we have 9Y, 11Y, 15Y and 30Y OATs totalling €10.5bn.

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