Another Truss moment?

The selloff in US treasuries continued yesterday over concerns that Donald Trump’s presidency would boost spending and inflation in the US, and make the Federal Reserve’s (Fed) job of bringing inflation back to the 2% target more difficult. The downside pressure slowed, however, after the ADP report showed that the US economy added slower-than-expected new private jobs last month.

But the minutes from the latest FOMC minutes clearly said – without explicitly mentioning a name – that the upcoming changes in immigration and trade policies may require a policy reaction from the Fed. And that reaction would be in the form of less interest rate cuts this year to contain inflation. Voila. The US 30-year yield flitted with the 5% mark for the first time since November 2023 before easing and the 10-year yield spiked above the 4.70% level for the first time since April and is set for a further advance to 5% - a level that will probably make it an interesting buy target for the US 10-year papers. Strong economic data could accelerate that journey, while a weak data – unless alarmingly weak – may not prevent it.

Another Truss moment?

The 10-year gilt yield advanced to the highest level since 2008 yesterday (after the 30-year yield hit the highest since 1998 earlier this week) during an aggressive selloff and broke above the peak levels that were reached during Liz Truss’ historic mini budget crisis and again during the summer/autumn period of 2023 on tighter Bank of England (BoE) monetary policy and growing fiscal concerns.

Today, the UK’s demons are back, driven by heightened fiscal concerns – evoking memories of Liz Truss’s chaotic 'mini-budget days.' Back then, markets lost confidence in the government’s spending plans, triggering an aggressive selloff that forced the BoE to intervene. The fallout toppled Truss’s government, setting the stage for Labour’s strong electoral win.

But now, the newly elected Labour government, which promised to rescue the country, improve finances, and boost growth, faces its own reckoning. To deliver on its ambitions, it needs market support – a resource proving elusive. Without it, borrowing costs will spiral higher, forcing tougher choices: more taxes, less spending, and weaker growth. And none of that bodes well for the pound.

Sterling tanked to 1.2320 against a broadly stronger US dollar. But this time, it also aggressively sold off against the euro. It’s time to step out of long sterling positions and wait for the dust to settle.

On the equities front, the FTSE 100 recovered earlier losses, as a softer pound is supportive of the FTSE 100 companies that make most of their revenues outside the UK, while the smaller British stocks are more vulnerable to political uncertainty and rapidly rising yields. Happily, many investors rely on the BoE’s power to calm down the game if things get out of control – and that’s perhaps limiting a further selloff in British stocks, altogether.

Elsewhere

Across the Channel, the EUR/USD also dived and traded below the 1.03 on the back of a strong US dollar buying across the board. The pair is consolidating near this level this morning. Whether it will continue its journey toward parity or make a U-turn toward the 1.05 level depends on where the US dollar will be headed next. Right now, the US dollar remains bid on the back of a hawkish shift in the Fed policy outlook versus a no particular change to the European Central Bank’s (ECB) softer stance. But a soft-looking data could rapidly change that dynamic and slow the US dollar’s appreciation near the current levels.

On the data front, figures released yesterday showed that the German factory orders slumped by  more than 5% in November, while the business climate and consumer confidence deteriorated in the Eurozone in December while producer prices jumped more than expected. The PPI rose to 1.6% in November from 0.4% printed a month earlier. A big part of it was already priced in – as the expectation was an advance to 1.5%. But the combination of weak sentiment and rising prices is never good for stock appetite. Still, for the contrarians, the German DAX index is expected to print the biggest EPS growth this year: earnings per share in Germany are expected to grow by 10%, followed by the Swiss SMI – expected to deliver a 9.5% EPS growth and France’s CAC 40 – expected to print an 8.8% EPS growth according to the data gathered by Bloomberg Intelligence. The British FTSE 100 is only at the 5th place from the top in this list with an expected EPS growth of only 5.9% this year. But a possibly U-turn in energy prices could change that expectation.

Crude oil made a great start to the year. The barrel of US crude remembered what it was like to sit above the $75pb level for a while, before returning to the $73-ish levels. From a technical perspective, crude oil is now in the medium-term bullish consolidation zone and should remain there above the $72.85pb support. But the growing concerns regarding China’s inability to boost growth could limit the upside potential into the 200-DMA – that currently stands just above $75.50pb.

And speaking of China, the trade tensions get tenser between the US and the latter. Earlier this week, China said it would curb exports of metals that are used in making batteries. And yesterday, Biden announced additional restrictions on AI chip exports – oh, after blacklisting Tencent and CATL, one of Tesla’s key battery suppliers. Nvidia dipped below $140 share after the bell, while quantum stocks tanked after Jensen Huang said that he doesn’t see quantum computers’ usefulness before 15 – or even 20 years. Note that the US stock markets will be closed today as day of mourning for Jimmy Carter, while the bond market will close at 2pm New York time.