FX Update: GBP vote of confidence on today’s budget statement.

FX Trading focus: Focus on sterling today on autumn budget statement. USD perks up with sentiment correlation even clearer now.

The US dollar has perked up, trading well off the lows of earlier this week as risk sentiment was in for a weak session late yesterday and into the morning hours in Europe today. The October US Retail Sales report was far stronger than expected, but this didn’t impress the US Treasury market, where yields fell to new local lows on a strong 20-year treasury auction and on the soft risk sentiment. US long yields and the US dollar going in opposite directions is a distinct change of behavior from the prior regime and these recent market moves suggest that USD traders mostly only have a nose for risk sentiment as the USD driver. Certainly, the next bits of incoming data ahead of the December 14 FOMC meeting are weak beer until at least the November 30 PCE data for October and then the November jobs report a couple of days later before what has now become the main event, the November CPI report just a day before the FOMC meeting. The dip in long yields unfolded with no change at the short end of the yield curve, so the 2-10 US yield curve inversion stretched all the way to -67 basis points yesterday, a new extreme since 1981 as recession fears intensify. It will take considerable work to reverse this USD move, and still think that it is too early to say that the USD highs are in for the cycle.

The chief focus today is on the UK Budget Statement, which is set to lay out a whole raft of measures intended set UK public debt on a sustainable trajectory over the coming five-plus years. Chancellor Hunt has said that the budget moves will be a mix of spending cuts and tax rises in an approximate 60/40 ratio. To avoid the Conservative party going down in flames at the 2024 election (or earlier?), many of the least popular measures like tax rises on personal incomes are not set to take effect until 2026-27, when the overall deficit trajectory is also meant to improve more sharply (the narrative is to avoid piling onto the near term recession risks in the near term, but the effect is really one of simply kicking the can down the road). Note on the spending side that the public pension will rose 10.1% (based on the September CPI) as of next April 1. I have a hard time seeing sterling finding further fuel for a sustainable rally on the back of this statement, but let’s see. It is certainly a critical vote of confidence today.

Chart: EURGBP
To keep the USD out of the equation, as it has been the biggest mover among G10 currencies of late, I will watch EURGBP over today’s autumn budget statement from Jeremy Hunt for isolating the vote-of-confidence, or lack thereof, for sterling. The pair has been trading choppily within the 0.8700 to 0.8800+ range ahead of today’s statement, discussed above, and a daily close on either side of the range points to the conclusions the market is making on the impact the coming fiscal austerity will have on the UK economy and its currency. The textbook observation is that fiscal austerity is currency negative, but the recent market repricing higher of sterling was more about avoiding a chaotic loss of confidence in the stability of the country’s finances. Upside for sterling is possible if the market has not yet fully unwound that “lack of confidence” discount on the currency and if the risk sentient backdrop brightens again as sterling seems to be highly sensitive to general swings in sentiment as well.