A whippy overnight trading session for all markets driven by media speculation of a U-turn in the UK government's budget proposals and another hot US CPI print

Speculation of a UK policy U-turn on taxes and a hot US CPI report have driven some remarkable market volatility overnight. UK rates have plunged and GBP has still been the best performer, highlighting how much bad news was priced into the currency. Fed rate hike expectations have ramped higher again and the US Treasuries curve has flattened. US equities have been unperturbed by the CPI report and rates backdrop, and they show a strong bounce. USD strength has given way. The NZD and AUD made fresh lows before recovering strongly.

It has been a whippy overnight trading session across bonds, equities and currency markets. Media speculation on a major U-turn by the UK government on its fiscal plans has intensified, with the snippets we noted yesterday being confirmed by government sources. The U-turn includes reconsidering more than £20b of unfunded tax cuts, including scrapping the £18b cut to corporate tax. This view has been supported by the fact that senior government officials refuse to endorse in public the plans outlined in the mini-Budget.

This “news” and a ramp-up of BoE gilt buying, has helped support the market. In the last two days of the emergency gilt operation the BoE bought £4.7bn of gilts, including of £3.1bn of index-linked bonds, the largest daily operation to date, a sign that funds are taking the opportunity to offload their positions ahead of Friday’s deadline. Gilt yields between 2-30 years maturity have fallen in the order of 20-25bps, with the short end supported by a paring of BoE rate hike expectations – the theory being that less fiscal easing means less tightening required. The peak policy rate is now priced around 5.55% for mid next year.

The US CPI report again came in hotter than expected, with the both the headline and ex food & energy measures surprising, at 8.2% y/y and 6.6% y/y respectively, the latter at a fresh 40-year high. The core monthly lift of 0.6% m/m (0.4% expected) suggests absolutely no downdraft in inflationary pressure, with five of the past six months coming in at that rate or higher.

While goods inflation is under better control, services inflation has ramped up recently, driven by higher rents which makes up 40% of the core CPI. All the indications are that the housing market is in recession and there is much less inflationary pressure on rents as measured by rent renewals, but these changes take a long time to filter through into the CPI measure. While some might point to this as a quirk in the data, other core CPI measures based on the median and trimmed mean continue to show rampant inflation of at least 7% y/y, given the broadly based inflationary pressure.

The strong CPI report cemented in expectations for another 75bps hike by the Fed early November, with the market now pricing in a small chance of a jumbo 100bps hike. And there is also now a good chance that rather than dial down December’s rate hike to 50bps, as projected by the Fed’s dotplot, the Fed maintains the 75bps per meeting pace. Fed Funds futures for the change in rates through to December jumped 10bps to 140bps. The peak in Fed Funds is now 4.85% for March next year, up from the 4.66% priced yesterday.

Higher short rates have fed through into Treasuries. The 2-year jumped as much as 27bps to a fresh high of 4.53%, but has since eased back to 4.41%, still up 12bps on the day. As you’d expect, the curve has flattened, with less upside pressure on the long end of the curve. The 10-year rate reached a fresh high of 4.075%, but has since fallen back to 3.92%, up 2bps on the day.

It has been whippy trading day for currencies and equities, reflecting the risk-on, risk-off, risk-on backdrop. Risk sentiment improved on the back of media speculation on the UK government’s expected U-turn on fiscal policy, slumped after the US CPI report, and has recovered again. It is not obvious why risk sentiment has turned positive again but there is sense that the market is looking through the CPI report, seeing the report as a lagging indicator when all the leading indicators are pointing to much lower inflation ahead. But that doesn’t gel with a more aggressive path of policy tightening ahead, so it might be just a case of positioning adjustments after the big recent sell-off in risk assets.

The S&P500 was down over 2% as the market digested the CPI report, but has since recovered strongly and is now up close to 2½%, with traders reporting a closing of some short positions. The DXY index was falling ahead of the CPI report, gained 1% on the report and has since slumped as risk appetite has returned, now down 0.6% on the day.

The NZD fell to a fresh low of 0.5512 following the CPI report, but has recovered some 2½% from that nadir to trade as high as 0.5655. The AUD fell to 0.6170 and has recovered to over 0.63. Some hope that some sense of normality will return to UK government policy has supported GBP which has punched up through 1.13 and recorded an overnight high of 1.1380. That GBP has been the best performer against a slump in UK rates highlights how much risk premia was previously built in. EUR is knocking on the door of 0.98.

USD/JPY punched up though 147 and reached a high of 147.67, 1pip above the 1998 high, would you believe, so now we can say the yen reached levels not seen since 1990. The hand of intervention looks suspicious at that high, with a spike down to 146.50 immediately after, and the currency now trading back around 147.

In the domestic rates market, 2-year swap fell early on reflecting global forces, before some payside pressure saw the rate move up to as high as 4.91%, before closing up 3bps on the day to 4.89%, a fresh closing high. The curve steepened, with the 10-year rate up 6bps to 4.70%. By contrast, the NZGB curve showed a parallel 2bps upward move across the curve out to 10-years.

In the day ahead, we’ll see the NZ manufacturing PMI, China inflation and trade data, with US retail sales and consumer sentiment data released tonight. Barely positive retail sales in nominal terms, as the consensus expects, would be consistent with negative growth in real terms. We’ll also be interested in what BoE Governor Bailey says as the emergency gilt buying programme is scheduled to end.