By Michael Brown,
DIGEST – Long-end Gilt yields rose to their highest since 1998 yesterday, as surprisingly strong US data sparked a broader hawkish market reaction. Another busy US docket awaits today.
WHERE WE STAND – Anyone have a lettuce handy?
I jest, of course, though the way Gilts are trading would suggest that participants are becoming increasingly concerned over the perilous UK fiscal outlook. 30-year yields sold-off to their highest level since back in 1998 yesterday, trading north of 5.20%. While this comes against a backdrop of significant global fixed income supply this week, with participants stepping up a gear as 2025 gets underway, underperformance in Gilts, compared to global peers, is again obvious. Compounding issues, yesterday’s 30-year auction drew the lowest demand since December 2023.
Importantly, the sell-off comes as fiscal headroom remains incredibly limited. At the time of the October Budget, the OBR estimated that a 1.3pp rise in gilt yields, and market expectations for Bank Rate, across the forecast horizon, would wipe out the entirety of Chancellor Reeves’ extremely limited £15.7bln headroom by which the fiscal rules are currently set to be met. Clearly, this puts the UK on an even more fragile fiscal footing, with the March ‘fiscal event’ increasingly likely to be one where Reeves is required to raise further funds, either via even more tax hikes, or greater borrowing.
Of course, said tax hikes will be politically difficult to deliver, with the definition of “working people” having already been stretched to the limit. In any case, data from the BRC yesterday pointed to retail sales growth of just 0.4% YoY in the final quarter of last year, along with retailers flagging the likelihood of further price hikes, and job cuts, in order to cover rising costs, including higher National Insurance bills.
Sadly, stagflation remains the ‘mot du jour’ for UK Plc – short GBP, and Gilts, seem the only reasonable positions as a result.
Across the Channel, price pressures are also bubbling away, with headline inflation having risen 2.4% YoY in the final month of last year, up 0.2pp from the pace seen in November, and the fastest such pace since last July. Nevertheless, the bulk of this increase was driven by higher energy prices, with core CPI holding steady at 2.7% YoY, meaning that Lagarde & Co will likely look through this blip higher in headline prices.
ECB pricing, hence, was largely unchanged, with a 25bp cut in both January and March still fully priced in, with a total of 100bp in the curve by year-end. This seems reasonable, particularly compared to overly-hawkish Fed pricing, with the USD OIS curve discounting just 40bp of cuts by December. This, then, could be another supportive influence on the common currency, so long as downside risks, principally on the trade front, weren’t to intensify.
Stateside, yesterday’s data slate largely beat expectations.
The ISM services index rose to 54.1 last month, a full 2 index points above the prior print, and further evidence of the continuing ‘US exceptionalism’ theme. That said, the aforementioned rise was accompanied by a surge in the prices paid metric, to 64.4, the highest level since February 2023 – further strengthening the case for a Fed ‘skip’ later this month.
Meanwhile, November’s JOLTS job openings figure also beat expectations, as the survey pointed to 8.098mln vacancies, well above the forecast range, and a 6-month high. Again, such a figure implies the labour market remains in rude health, and that the Fed can take their time in determining the appropriate juncture for delivering further policy easing.
Unsurprisingly, these figures combined to elicit a hawkish cross-asset reaction. Stocks, subsequently, ended the day sharply lower, with the S&P and Nasdaq both falling by well over 1%. Meanwhile, Treasuries sold-off across the curve, with losses led by the long-end, as benchmark 10- and 30-year yields rose by over 5bp apiece, the latter climbing north of 4.90%. In turn, this saw the dollar advance, with the greenback gaining around 0.3% against a basket of peers, as cable sunk below the 1.25 handle, and the EUR dipped back beneath 1.0350.
LOOK AHEAD – Another busy day awaits, ahead of most US markets being closed tomorrow, in observance of the National Day of Mourning in recognition of the passing of former President Carter.
Of today’s releases, all of which are due from the US, minutes from the December FOMC meeting are likely to be of most interest, as participants continue to seek clarity on the policy path that Powell & Co are likely to plot this year. Recall, the December meeting saw the Committee deliver a hawkish 25bp cut, pointing to just two further such moves in 2025, with the base case now being that a ‘skip’ will be delivered later this month.
Other prints due today include December’s ADP employment report, which will likely bear little resemblance to the official payrolls figures due on Friday, as well as the weekly jobless claims data, where neither the initial nor continuing claims prints pertain to the aforementioned jobs report. This week’s packed slate of US supply also wraps up today, with $22bln of 30-year bonds due to be sold.
Brown is Senior Research Strategist at Pepperstone
