US dollar breaks above key levels but buying subdued

USD: Shutdown hits new record as focus shifts to Supreme Court

The US dollar advanced to levels above 100 in DXY yesterday and EUR/USD broke below the 1.1500-level although the technical breaches of these levels has not as yet triggered any increased momentum for buying. The government shutdown continues and today reached a record 36 days surpassing the previous longest from 2018-19. There have been some positive noises from Washington suggesting there could be a deal to re-open government. The deal would involve signing a short-term bill to re-open government with some of the 12 annual appropriations bills that are needed to fund government agencies. This would not be a complete resolution but would allow a re-opening. The Democrats in turn would get a vote on expiring ACA subsidies. A deal could be in place by the end of the week. That would then pave the way for the backlog of jobs data to be released. If the labour market has remained weak similar to the data of recent months, that could help prompt a turn in dollar buying momentum.

Ahead of any government shutdown deal, today we have the Supreme Court hearing of arguments in relation to the legality of using IEEPA for implementing reciprocal tariffs globally. The hearing will be crucial in shaping expectations on the possible outcome of the ruling to be given at a later date, possibly by January. The hearing will begin at 15:00 GMT and is set to last 80 minutes with 40 minutes for the US Solicitor General to defend the legality of the tariffs used under IEEPA followed by 20 minutes for the private business plaintiffs arguing against the tariffs and a further 20 minutes for the coalition of 12 states also arguing against the tariffs. The type of questions posed by the Supreme Court judges will be important in shaping expectations.  

With tariffs estimated to being in up to USD 400bn in the first twelve months the ruling will have implications for the UST bond market and the dollar. Still, it is highly likely that the Trump administration will have plans in place to offset the removal of IEEPA with greater use of other trade acts to hit imports on a sector-by-sector basis. Section 232 (national-security reasons); Section 301 (act against unfair trade practices); Section 201 (halt import surges) are some of the avenues open to Trump. White House Press Secretary Karoline Leavitt stated they are “preparing for Plan B”.

The consensus appears to be marginally in favour of these tariffs being voted down and if today’s hearing does shape expectations in that direction then it elevates uncertainties once more and could potentially prompt some turnaround in the recent dollar buying momentum. A government shutdown that brings forward possible labour market data could also encourage some reduction in recently built long dollar positions.

US CONSUMER EXPECTATIONS OF FEWER JOBS REMAINS ELEVATED

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Reeves signals tough budget or plays politics?

The pound was for much of yesterday the worst performing G10 currency although it ended the day third worst as Gilt yields initially gapped lower on the open before modestly recovering in response to the early morning speech by Chancellor Reeves. A pre-budget speech like this is not usual and there appeared an intent to send a message to the voting public and the markets that tough action would be taken. The 2-year Gilt yield gapped 5bps lower initially as the rhetoric from Reeves implicitly signalled the potential for tax increases that went against promises made in the election manifesto. There were at least two questions in which the context of the question was that manifesto promises would be broken and Reeves answered the questions without challenging the premise of the questions. So the financial markets understandably took this speech as increasing the likelihood of bigger tax hikes. In particular Reeves reference to seeking budget headroom that could “withstand global turbulence” and the budget would build “more resilient public finances” certainly implied a larger headroom than the GBP 10bn that existed after the budget a year ago. Given this comment a doubling of the headroom seems very plausible. Gilts likely did also perform well on Reeves stating that the focus of the budget would be to lower inflation and ease the cost of living for UK households. Reeves added that she planned to create the “conditions for a rate cut” These comments also increased expectations that perhaps the BoE could surprise the markets and cut by 25bps this week.

But there must also be a chance that this speech was very much about setting expectations, and possibly expectations that can then be surpassed on budget day that results in a more positive reaction in the media and the markets. Bar this speech, the other important piece of budget news yesterday was the pre-budget analysis published by the Resolution Foundation that concluded that the much-reported fiscal hole that needs filling could be a lot smaller than currently assumed. The Resolution Foundation suggests that the productivity downgrade that lifted expectations of the size of the fiscal hole could be offset by stronger wage growth and estimate a hole of GBP 14bn rather than estimates that range between GBP 25-40bn. The Resolution Foundation has close links with the Labour government and its former head Torsten Bell is now Parliamentary Secretary for the Treasury and is working closely in shaping the budget.

If the fiscal hole is smaller than expected, it is certainly feasible that the budget could then raise enough revenues to build a larger fiscal headroom while also avoiding a breach of the key election manifesto promises. It might therefore be that the negativity related to the budget pushing Gilt yields and the pound lower could become overdone. It also highlights why the BoE is likely to hold off from cutting this week given the uncertainty related to the outcome of the budget is high and by the December BoE meeting the MPC will be able to fully assess the budget and will have two CPI and jobs reports to hand as well. In the meantime though, the pound is likely to continue to underperform on the expectations of a harsh budget. The rates market pricing implies a 30% probability of a cut tomorrow.

GBP SELLING HAS PICKED UP SINCE MUCH WEAKER UK CPI DATA

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com