It’s All Getting A Little Ugly

WHERE WE STAND – Things seem to be getting rather ugly out there.

It was another risk-averse day on Wednesday, with participants yet again trading on the back of Trump tariff headlines – however wearisome this has already become, recall that we still have another four years of this to go!

Reports from CNN were the spark which ignited a risk-off move yesterday, as headlines broke that President-elect Trump was planning to declare a ‘national economic emergency’, in order to provide legal justification for the planned imposition of universal tariffs on imports to the US. Importantly, such a declaration would allow Trump to impose tariffs without a requirement to prove that such measures are necessary on national security grounds, with sources noting that “nothing is off the table”.

It seems, then, that, after a brief glimmer of hope on Monday that tariffs may not be as wide-ranging as feared, participants are back to pricing a worse-case scenario, and are hedging the risk of a protracted tit-for-tat trade war as a result. Furthermore, the headline barrage over the last three days has been another reminder of the policy uncertainty that now lingers over Washington DC, subsequently leading to higher cross-asset vol, and markets needing to price a substantially greater risk premium. Hence, stocks slipped once again, Treasuries sold-off as 30-year yields climbed ever closer to 5.00%, while the dollar rallied as the DXY cleared the 109 handle once again.

Notably, this is process of pricing higher risk premium is unlikely to stop once Trump is inaugurated, particularly with historical parallels pointing to this method of policymaking likely continuing throughout Trump’s second term.

Consequently, as participants brace for this elevated uncertainty to continue, most appear to have adopted the following ‘default position’ – flat risk, long USD, and short long-end Treasuries. Fading any of those positions seems folly for the time being, particularly considering that the aforementioned risk premium likely still needs to be priced to a much greater degree.

Here in the UK, things are also getting rather ugly.

Gilts once again sold-off across the curve yesterday, with weakness led by the long-end; benchmark 10- and 30-year yields both climbed by over 10bp on the day, touching their highest levels since 2008 and 1998 respectively.

The market’s worry here is two-fold. Firstly, the UK continues to deal with the issue of sticky inflation, particularly stubbornly high services prices, which in turn leaves the BoE toeing a much more hawkish line than most of their G10 peers. Secondly, concern persists about the perilous fiscal backdrop, with stagnant growth, and the continuing Gilt sell-off, having all but wiped out Chancellor Reeves’ fiscal headroom, which was already incredibly slim at around £10bln.

Of more concern, though, is that the climb in Gilt yields has been accompanied by a chunky sell-off in the pound. Cable fell over 1% yesterday, slipping back into the low-1.23s, as spot slipped to fresh lows since last April. Derivatives, meanwhile, point to this GBP weakness continuing, with one-week GBP/USD risk reversals having fallen to their most negative since early-November, implying puts trading at the biggest premium over calls since election day.

This dynamic, of yields moving higher, as the respective currency falls, is a classic sign of fiscal de-anchoring taking place, and of participants losing confidence in the Government in question’s ability to exert control over the fiscal backdrop.

We’re not at the Truss/Kwarteng stage just yet, but things are clearly on very shaky ground indeed – short GBP remains my preference.

LOOK AHEAD – With US participants away from their desks today, in observance of the National Day of Mourning for former President Carter, a subdued day could well await.

Certainly, the data docket presents little of interest, with the only release of note being this morning’s eurozone retail sales report. Sales are expected to have risen by 0.3% MoM in November, though the figure is clearly somewhat stale, and shan’t materially alter the ECB policy outlook.

Besides that, the calendar does include five scheduled Fed speakers, though one would expect those remarks to be postponed. BoE Deputy Governor Breeden is due to speak, though, with any thoughts on the recent tumult in the Gilt market likely of particular interest.