GBP

GBP trader - The week where UK politics wrestled control from the Fed

Chris Weston
Head of Research
16 Oct 2022

UK politics commands the international spotlight from time to time and that time is now. Yet, while we fraternise over Fed policy and how high the Fed could take the fed funds rate into 2023, UK politics and the impact on the UK gilt (bond) market and the GBP is firmly front and centre – the connection between British politics and the capital markets will almost certainly result in increased volatility for the GBP this week.

The last few weeks have been one which has not only captivated the world’s financial markets but could be a case study for those bright academics studying at Oxbridge, keen for a future position in the cabinet, on just how mighty the markets can be – and of course, how not to implement new fiscal policies.

Truss’s time as PM seems to be slipping by the day, and the weekend press is alive with speculation of a revolt that could soon see 1922 Committee head Graham Brady giving Truss the nod to step down. Naturally, Rishi Sunak is feeling his time to lead is fast approaching and his view that Truss’s tax policies would cause wild gyrations in financial markets have been vindicated and greatly enhanced his brand. Further speculation that Defence minister Ben Wallace may be in the running as a future PM and is also doing the rounds.

Truss is moving away from the agenda to spend and talk of “austerity” is becoming ever louder. After last week’s call from the Institute of Fiscal Studies that the UK is in the hole for around £60b if the tax cuts go ahead without massive adjustments to spending is one that has been fully acknowledged and the sums are there for all to see - Truss’s credibility is shot to pieces, and uncertainty is the short-term dynamic that will further rattle UK financial markets.

While a change of guard is heavily debated, it won’t happen overnight. The question in the near term is whether Jeremy Hunt can win over the capital markets. Hunt and BoE Bailey seem to have bridged some gaps, which is a GBP positive – yet, while Hunt is well respected within party ranks, the consensus position is that Hunt is facing a true uphill battle and even if the remaining tax cuts are rolled off then the Truss govt will also have to cut spending and that will win her even fewer friends, at a time when her approval rating is at rock bottom.

The Sunday papers are already detailing that we’re to hear of further U-turns and a repel of Truss’ ‘mini budget’, with a formal announcement that the planned reduction to the basic rate of income tax will be pushed out by 12 months – more measures should be announced through the week.

In a world where we analyse the distribution of outcomes in markets, unless we get a true risk on vibe through markets, lifting equities higher, then rallies in GBPUD will likely be sold and over the short-term. Subsequently, the path of least resistance for the GBP is, therefore, lower, with EURGBP longs likely getting a strong showing as traders look to take the USD out of the equation.

Hunt seems to have found a friend in BoE gov Andrew Bailey, but the markets may take their pound of flesh and go after something more substantial – they want to feel real credibility. They want a firm government that truly understands the balance between fiscal policy, monetary policy, and government issuance – A Truss/Hunt combo doesn’t quite cut the mustard.

With the BoE’s temporary bond-buying program out of action – for now – we watch the UK gilt market reaction, and any rection that pushes UK 30-year gilts towards 5% and above. FX traders will get their say before the UK bond market opens and early signs are they are covering GBP shorts – I sit in the camp that the picture remains grim, and traders will fade strength into 1.1350/80. However, an open mind is always advantageous when dealing with flows around the interpretation of politics and markets.

It’s another big week for markets – the UK bond market will be front and centre – judging the link between politics and markets is always a struggle but where do you see the balance of risk?

Aside from the above market consideration, traders will need to navigate -

  • UK CPI (Wed)- the market expects no change at 9.9% - above 10% and it could get lively in the GBP
  • EU CPI (Wed) – a big jump expected to 10% - we also get a raft of ECB speakers too and ahead of the ECB meeting (27 Oct) we can see the market pricing a punchy 75bp hike at this meeting
  • NZ CPI (18 Oct - 08:45 AEDT) – the market expects CPI to fall to 6.5% from 7.3% - could this set a trend of firmly lower inflation reads in G10 FX countries?
  • China Q3 GDP and industrial production (18 Oct at 1pm) – the market expects Q3 GDP to come in at 3.5% - a solid rise from the Q2 pace of 0.4%.
  • Aussie employment (Thurs at 11:30 AEDT) – 25k jobs are expected to have been with the unemployment rate unchanged at 3.5% - Hard to see a number that changes the markets view of a 25bp hike in the November RBA meeting.
  • No tier 1 US data – we do get 9 different Fed speakers and their views could move markets – the data suggests they should all be hawkish.
  • US earnings – 15% of the S&P500 report – including Netflix, IBM, and Tesla

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