USD slides on Fed Chair speculation and RBA rate hike speculation

USD: Renewed selling could extend further

The US dollar has broken back lower after failing to advance through some key technical levels with numerous factors prompting the reversal. The release of US data yesterday certainly helped with the retail sales and PPI data for September coming in weaker than expected and offering no reason for the markets do doubt the renewed conviction of a rate cut on 10^th December. We had started to doubt a December rate cut following the better NFP jobs data but clearly there are still a number of FOMC members who see reason to cut and then perhaps enter a pause period to assess.

Dollar selling extended further following reports that Kevin Hassett is in prime position to be announced as the new Fed Chair. One of our reasons for maintaining a bearish view for the US dollar into year-end was the risk of Hassett getting the job. He remains the favourite in betting markets and the reports yesterday have reinforced expectations of him getting the job. The other main contenders – Waller, Bowman and Warsh – all have Fed experience and hence there is greatest risk in a Hassett nomination. He is also closest to the Trump administration and would be expected to attempt implementing change more aggressively than the other contenders. His choice would reinforce the belief that Trump will pursue fundamental change to how the Fed operates going forward. Those expectations will likely incorporate a belief that the Fed will lean its policy bias more in favour of full employment than price stability that would likely result in a stepper yield curve – a dollar negative development. Hassett could also be more willing to express his policy views despite there still being nearly six months before Fed Chair steps down.

Dollar selling was also prompted by the much stronger than expected inflation data from Australia. The trimmed mean annual CPI rate jumped from 3.2% to 3.3% in October – the markets expected a drop to 3.0%. Australia is shifting to a monthly CPI data series from the usual quarterly and hence the RBA will likely view the data series with some caution initially to gauge how volatile the data may be. But nonetheless, the upturn in inflation following the RBA minutes that indicated a symmetric bias to the policy outlook has resulted in the OIS curve now building in a view that the next move will be a hike. This is an important moment in G10 and comes on the same day when the RBNZ cut but provided  a hawkish guidance indicating the easing cycle may be over. A weak yen could yet see the BoJ surprise the markets and hike in December although January remains more likely. December is now close to priced as a 50-50 call. Further dollar selling looks plausible especially if the UK budget is greeted favourably by the markets – see below.

AUSTRALIA SHORT-TERM YIELDS RELATIVE TO US YIELDS FAILING TO PROVIDE AUD/USD SUPPORT FOR NOW

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Budget day arrives under a cloud of gloom

The constant stream of media leaks and speculation on what will or will not be included in the Autumn budget comes to an end today with Chancellor Rachel Reeves presenting the budget in parliament immediately following PMQs at approximately 12:30 GMT. Reeves faces a difficult task with a high level of media criticism over the drip-feed of information on possible tax increase measures that has created a level of uncertainty that has undermined confidence. The GfK Consumer Confidence index reported last Friday fell from -17 to -19 with a worsening of personal finances over the coming 12mths partly explaining the drop. Retail sales in October cam in much weaker than expected and the preliminary PMIs for November all declined as well.

GBP moves will likely take a lead from the reaction in the Gilt market. The 10-year yield fell sharply in October only for half of the 40bp drop (intra-day high to low) to be retraced in days last week. It’s difficult to be precise in terms of what the markets are expecting today but market participants certainly expect to see income tax rises avoided; a wide array of tax increase measures will be announced instead – a freezing of income tax thresholds for two further years; a cap on tax-free salary invested in pensions; an increase in council taxes on higher-valued properties; and changes to capital gains and gambling taxes. Measures to help reduce the cost of living are also expected with green levies included in energy bills to be reduced or removed. The FT reported yesterday that a plan for a  VAT cut to energy bills has been scrapped.

Key for the bond markets will be headroom and credibility. GBP 10bn of headroom in recent budgets has clearly not been enough and we along with the market expect at least an increase to GBP 15bn and possibly GBP 20bn. A level of at least GBP 20bn would be required for a positive Gilt market reaction. If the OBR estimated budget hole is approx. GBP 20bn with that and the increase in headroom and some giveaways of possibly GBP 5bn, the tax raising and spending cut measures will need to total GBP 30-35bn. The greater the array of tax measures, especially new untested tax increases, the greater the risk of a lack of credibility that could prompt a sell-off of Gilts that would likely see GBP follow. The DMO Gilt issuance update and the OBR updated forecasts, released after the budget speech could also influence market reaction. One key difference though to recent budgets is the fact that inflation is now falling more clearly toward target with wage growth also easing – so the bond market backdrop is somewhat more favourable than in recent years.

The market is now implying a 90% probability of a rate cut in December with a further 40bps of easing priced for next year. A tough credible budget that sees that extent of easing priced increasing is unlikely to be dramatic enough to weigh on the pound. Sentiment ahead of this budget has been very negative and options pricing points to a bias favouring GBP depreciation. That could mean a budget in line with expectations that doesn’t include any nasty surprises and is reasonably credible could prompt a reversal of recent market moves and GBP shorts are squeezed. The BoE GBP TWI is trading at levels not seen since January when there was a fiscal credibility sell-off after the Oct 2024 budget and suggests a level of bad news is priced into FX.

EUR/GBP OVERNIGHT 25 DELTA RISK-REVERSAL SPIKES HIGHER AHEAD OF TODAY’S BUDGET – A LEVEL OF BAD NEWS SEEMS PRICED

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com