Sovereign International Daily Market Report

Truss resigns as UK Prime Minister, US yields rise to fresh highs

Summary:

• Sterling briefly rallies after Liz Truss resigns as UK Prime Minister after six turbulent weeks in office.
• GBP gives up its gains, as markets dial back bets in favour of BoE interest rate hikes. Attention turns to her potential replacement.
• US Treasury yields rise to fresh highs on hawkish Fed member communications.
• Euro largely trades in line with risk sentiment, as investors eye next week’s ECB meeting.

Another highly eventful 24 hours or so in UK politics continued to dominate much of the headlines in the foreign exchange market on Thursday.

The resignation of Liz Truss after a mere 40 odd days as Prime Minister, the shortest premiership in UK political history, made for choppy trading. Sterling was initially buyed on the news, rallying by over one percent on the day against the US dollar at once stage. The Truss era, if we can even refer to it as such, will forever be marred by the uncertainty it created in UK financial markets. Her calamitous budget announcement, which sent the pound crashing to a record low, gilt yields through the roof and caused credit rating agencies to downgrade their outlook on Britain’s economy, will go down in infamy. In all honesty, markets breathed a sigh of relief that this particular episode in UK politics is over and that the saga surrounding the budget can be put to bed.

That said, even following Truss’ resignation the pound is not out of the woods just yet, with sterling giving up much of its gains yesterday afternoon. Uncertainty in British politics remains rife, which will do little to inspire confidence in UK assets. The next Prime Minister and Tory leader is expected to be chosen by next Friday. There have been reports that Boris Johnson is ready to throw his hat back in the ring, but we see another stint for the former PM as highly doubtful. Former chancellor Rishi Sunak and Leader of the House of Commons Penny Mordaunt are the front-runners, but whether either candidate will be able to steady the ship remains to be seen.

Another issue for GBP is the impact of the Truss resignation on BoE monetary policy. Markets have gone from fully pricing in a 125bp rate hike at the MPC meeting in November, to now barely expecting a 75bp one. MPC member Broadbent hinted this week that the bank may fall short of market expectations in the coming months - something we’ve been saying ever since the mini-budget announcement. This morning’s rather concerning UK retail sales figures will likely further dampen these expectations. Sales collapsed by 1.4% in September, down 6.9% on the year, a much larger drop than the -5% contraction expected.

A broadly stronger US dollar in the second half of London trading yesterday can also partly explain the pullback in GBP/USD. US Treasury yields have continued to march to fresh highs this week, as investors ramp up bets in favour of Federal Reserve rate hikes following last week’s inflation report. The 10-year Treasury yield has increased above 4.2% - the first time it has done so since 2008. There hasn’t been too much US macroeconomic data out this week, although news that we have had has been largely encouraging, namely better than expected jobless claims and building starts numbers. Communications from FOMC members have not necessarily rocked the boat this week, though the general tone has been a hawkish one. Philly Fed President Harker said yesterday that rates will need to keep rising for ‘a while’, citing a lack of progress made on the inflation front.

For the most part, trading in the euro has followed that of broad risk sentiment this week. Again, it has been a rather quiet week news wise out of the common bloc. That will change next week, as the European Central Bank will be announcing its latest policy decision. Another 75bp rate hike is heavily expected by markets, so expect attention to be firmly on Lagarde’s comments regarding the possible pace of tightening from the December meeting onwards. With Euro Area inflation showing no signs of abating, we think there is a strong possibility the ECB hints it may need to raise rates deeper into 2023 than the market is currently pricing in. Such rhetoric, or a shock 100bp rate hike, would likely provide solid support for the euro in the second half of next week.

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