UK Gilts ahead of the pack
21 May 2010
The Macro Trader’s view:
We wrote a Market Update on the day of the UK General election outlining 3 possible scenarios for the Gilt market post-election.
We noted how we thought the market would rally on two of the possible outcomes:
1. An outright Conservative victory, or
2. A conservative led coalition with an overall majority.
In the event, the second outcome occurred and the Gilt has indeed rallied. The coalition Government has put fiscal consolidation at the centre of their agreed program. This makes the UK the only major economy with a coherent, coordinated and credible plan to fast track cuts to the budget deficit and public spending.
Although the previous administration also planned to cut the deficit, their plans lacked credibility and the time-frame was probably over too long to prevent either
- the markets from losing confidence, or
- prevent the rating agencies from cutting the UK’S AAA rating.
The new government’s fiscal plans also underscore the Bank of England’s stance on official interest rates. Last week’s quarterly inflation report forecast inflation would fall back below target based on the current level of Bank rate and existing deficit-reduction plans.
With the deficit now set to be cut faster, the Bank will leave short term interest rates at current levels for an extended period allowing the yield curve to flatten.
But these are not the only reasons for the rally in Gilts. Government bond markets have turned decidedly bullish in recent days as traders continue to worry about the Sovereign debt crisis in the Euro zone.
Although peripheral countries are taking steps to cut both spending and their budget deficits, the fear is now that the medicine is so severe that it risks forcing a dip back into recession. The mood hasn’t been helped by Germany’s decision to unilaterally ban naked short-selling in 10 of its key financial stocks and Euro denominated government debt.
In short, the fragmented nature of policy making in the Euro zone led to the initial lack of confidence that first hit Greece, now that fragmentation has been re-enforced by recent German actions: the Euro zone has one monetary policy, but multiple fiscal and political decision centres which have caused the fault lines now so evident.
How has this helped the Gilt?
Quite simply, the Gilt is now seen as a safe haven trade, along with the Bund and US Treasury market and because of the new government’s plans it is leading the pack.
The Technical Trader’s view:
MONTHLY CHART
This market is undeniably well-structured: note well the support from the 1994 High at 105.03, see how well it performed on successive bear attempts - total four …
The note the creation of a bull falling wedge in the last week.
The minimum target of that wedge is surely the Prior high at 124.95…
WEEKLY CHART
The detail of the bull move – and the completion of the falling wedge.
The first point of reference is the old High 120.82, but then 125.58.
On any pull back expect the diagonal at 117.00 to be good support.
Mark Sturdy
John Lewis
Seven Days Ahead
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