Morgan Stanley — UK Rates Strategy: Maintain Short 5s10s30s SONIA Butterfly
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UK Rates Strategy: Stay Short the 5s10s30s SONIA Butterfly
Morgan Stanley stays short the 5s10s30s SONIA butterfly (receive the fly) and keeps a bullish bias on front-end linkers. The UK curve already prices more tightening than the bank's base case, with markets attaching over 50% odds to back-to-back hikes at non-forecast MPC meetings such as December and March. Front-end yields face twin headwinds: energy prices and hawkish repricing in US front-end rates, adding to downside risks.
The upcoming Budget is the other swing factor. Morgan Stanley expects deficits to be revised up from 3.6% and 2.9% of GDP to 3.9% and 3.7% in FY2026/27 and FY2027/28, lifting gross gilt supply from roughly £250bn this year to about £300bn by FY2027/28, with a ~£3bn marginal increase in FY2026/27 financing needs. T-bill issuance should rise by £10-20bn a year (base case £15bn). Swap spreads have been resilient but remain vulnerable to volatility spikes and long-position unwind. Recommended trades: short the 5s10s30s SONIA fly, long 5y real yields, and the UKT 4R54/5R56 ASW box flattener.
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