Morgan Stanley: Three Rate Hikes Priced In - Risk/Reward Favors Money-Market Longs
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Morgan Stanley's UK rates team notes that rising energy prices keep lifting terminal-rate pricing across G3 central banks: the SONIA curve now embeds close to three hikes, with November hike odds above 50%, while 2y SONIA sits roughly at fair value against the team's energy model using Brent and gas futures curves. Pricing has approached the non-energy Taylor-rule path in the BoE's July MPR adverse scenario, yet SONIA option mean-median spreads peak near 15bp - hawkish pricing rarely sits in the tail - and medium-term inflation expectations remain anchored, so the bar to pricing a deeper tightening cycle is high and risk skews toward dovish repricing. The team has switched its SFI M7/M8 steepener (exited at -1bp versus -4bp entry) into an outright long in M7 at 4.42%, targeting 4.20% with a 4.52% stop, and retains its 5-year real-yield long. August's Decision Maker Panel was relatively benign: one-year CPI expectations fell from 3.4% to 3.1%, three-year expectations are around 2.8%, and wage expectations still imply roughly 60bp of wage-growth cooling over the coming year. Long-end duration gained across markets on moderately supportive fiscal news ahead of the October 28 Budget. With 10y asset swaps near three-month wides, the team closed its 10y ASW long, turned neutral on spreads, and flagged that positioning remains long, posing unwind risk if fiscal sentiment deteriorates.
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