[MARKET ANALYSIS] A UK surplus supports Gilts while Bunds fade from highs as Manufacturing returns to expansion

• USTs are near enough flat in thin 112-29+ to 113-02 parameters. Specifics for the space are somewhat light thus far as we count down to a packed 13:30GMT data docket and await any further insight on US-Iran tensions before potential SCOTUS opinion(s) at 15:00GMT.
• Gilts had two leads to digest at the open. Stronger-than-expected retail sales, though with caveats, were a bearish driver as the data doesn't push BoE's Bailey (or any of the hawks, particularly focused on Mann) towards voting for a cut in March vs April; however, ultimately, the data will have little impact on that discussion. Separately, a larger-than-expected government PSNB surplus in January served as a bullish driver, as the series that provides the Chancellor with even more headroom, i.e. on top of the extra c. GBP 10bln of space she has gotten in recent weeks from yield moves.
• Ultimately, and unsurprisingly, the lead from PSNB won with Gilts gapping higher by 19 ticks and then climbed the same amount again to a 92.59 peak, notching a fresh WTD and MTD high, just shy of the YTD and H26 contract high of 92.95.
• Gilts came off best levels alongside EGBs into the morning's UK PMIs, a series that printed above consensus across the board. Within the series, S&P's Williamson wrote that "relatively modest price pressures being signalled and ongoing worrying labour market weakness will likely result in a growing call for further rate cuts".
• Bunds spent the morning firmer, with gains of 20 ticks at best, notching a 129.45 peak, strength that seemed to just be a continuation of recent gains. Thereafter, the benchmark fell from best and moved to near-enough unchanged on the session at a 129.28 trough following the morning's PMIs, which were generally strong and particularly so for manufacturing, which unexpectedly returned to expansionary territory for Germany for the first time in over 3.5 years.

The UK data today revealed a larger-than-expected government surplus, positively impacting Gilts as they gapped higher. Meanwhile, stronger-than-anticipated manufacturing PMIs in Germany suggest economic recovery, but Bunds faded from earlier highs due to mixed implications for future rate policy, highlighting differing market sentiment between UK and German bonds.