BOE divides Goldman Asset, State Street in bets on UK markets

London

INVESTORS are at odds on how to trade UK markets as they question just how much the Bank of England (BOE) will hike interest rates next year.

That is leading money managers at Goldman Sachs Asset Management and Allianz Global Investors to bet against the pound, in opposition to State Street, which thinks the currency looks cheap and worth buying on dips given the chances for policy tightening.

For all their disagreement, they still expect fewer hikes than the multiple moves seen by money markets, following a surprise pause by the BOE this month. While policy dilemmas are being faced by central banks around the world, trying to avoid imperilling a recovery from the pandemic, the BOE is dealing with fresh Brexit trade concerns and labour shortages thrown into the mix.

"Volatility always creates opportunity, and we think the opportunity now is to bet against the super-aggressive rate hikes that are priced in," said Mike Riddell, who manages about US$9 billion at Allianz, and is positioning for a slide in sterling and a rally in UK bonds. He believes growth and inflation should drop sharply from the second quarter to reduce the chances of further BOE policy tightening.

It is a worry shared by Goldman Sachs Asset Management, which thinks the BOE will raise rates before any of its major peers but is still betting against the pound. That is partly because of the risk of further disruption to trade between the UK and European Union.

Any move by the government in London to follow up on threats to invoke Article 16 of the Northern Ireland protocol, which governs trade, risks retaliation from Brussels could hurt the pound and influence the BOE's calculations on monetary policy. Money markets are pricing a hefty 90 basis points of hikes to 1 per cent by September.

Goldman's global fixed-income portfolio manager Hugh Briscoe predicts the UK central bank will raise borrowing costs next month before 2 more increases by June 2022. Yet in contrast to Allianz, that leads him to wager against UK government debt.

It is a similarly confused picture among bond analysts. With only 6 weeks until year-end, strategists surveyed by Bloomberg are predicting an array of different levels for 10-year gilt yields. The range is from a drop from the current 0.88 per cent to 0.7 per cent, or a surge to 1.25 per cent, which would be the highest level since 2019.

Guessing the central bank's next move is becoming more of an art than a science. UK rates traders are hedging next month's meeting at levels that have not been seen in years, with the volatility on 1-month-2-year swaptions near its highest level in at least a decade.

The evolving threat of Covid-19 is also complicating the picture. With Austria preparing for a nationwide lockdown from Monday and a similar prospect looming in Germany, any renewed restrictions could cause blowback for the UK just as its economy is finding its feet. That sent bond yields sliding across the region Friday (Nov 19), on haven buying.

The uncertainty is leaving Amundi's chief investment officer for the UK, Laurent Crosnier, avoiding exposure to markets going either up or down.

"Reaction functions of central banks have changed over time and the reading of macroeconomic data is not enough to understand the market's behaviour," said Crosnier.

The best way to position is to reduce directionality in trades and bet on either inflation break-evens or the yield curve, favouring flattening strategies, he said. "In this environment, flexibility remains key." BLOOMBERG