Sunday, January 29, 2006

UK interest rates...not going up any time soon, buy Short Sterling.

Lets look at UK interest rates (see previous blog yesterday for
discussion on the currency):

1. The Bank of England has been voting 8-1 for a cut in rates
2. The consumer slowdown is in force, thanks to a borrowing binge that
has left most of the country in debt
3. House price inflation has ground to a halt, so people that felt they
were getting richer over the last few years as their main asset rocketed
in value may start to feel poorer
4. Government spending has been out of control, and the Chancellor is
finally starting to realise it. Public sector spending helped the boom
over the last few years, now it will bring on the contraction.

So it seems rates are not going up, how best to play this? With 10y
Gilts yielding just 4.15%-4.20%, buying long bonds does not seem to be
an obvious trade (especially when long bonds in £ seem to be in the
midst of a bubble...I won't even BEGIN to tell you what I think of the
market lending money to the UK Government for 50 years at just
3.70%...well, maybe I will another time...). A simpler and lower risk
trade looks to buy some short interest rate futures (Short Sterling, if
you don't know the lingo)...I bought some Dec '06 Short Sterling at
95.36 on Friday in £25 a point. At 95.36, that is saying that 3m rates
in December this year will be 4.64% (100.00 - 95.36), but it seems to me
there is a good chance of a rate-cutting cycle starting this year, so
with the BoE at 4.50% this looks a low-risk/high-upside trade. I'll be
watching it over the coming weeks with a view to taking it up to £100 a
point.

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