In the absence of the US, the UK sat on the headlines yesterday, with its debt drama. Everyone threw in what he or she thought about what today’s situation reminded them. The discussions went from the latest aggressive selloff triggered by Liz Truss to 1976 debt crisis when the UK had to ask IMF help to get its head above water. I don’t think that the UK is there just yet, and yesterday’s retreat in yields (after reaching fresh highs) *without the Bank of England’s (BoE) intervention* was more than welcome. But the fact is, Rachel Reeves is losing her fiscal headroom and her manoeuvre margin with every basis point rise in borrowing costs, and that muddies the UK’s growth outlook. In numbers, the 10-year gilt yield has risen around 60bp since Rachel Reeves announced her latest budget. Note that the yields didn’t rise as spectacularly and immediately as in reaction to Liz Truss’ mini budget disaster, but the yields are now above Liz levels – and that leaves the UK government with three choices: either they will announce more tax rises, or lower spending, or both. According to people who are familiar with the matter, it would be the second option: lowering spending plans in the first instance. Maybe that’s what brings some relief to investors. But in all cases, the UK’s drama in not over. Cable has now slipped below the 1.23 mark and is set for a deeper selloff. Price rebounds could be interesting opportunities to strengthen short positions and target the 1.20 support. On the euro front, we should see consolidation and extension of the latest gains in favour of the euro.

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Fun fact before we move on. The UK – which has a huge debt, dismal productivity and growth and a thick layer of unnecessary regulation like continental Europe – still has a debt-to-GDP level lower than other developed economies like France, Italy, Spain and Japan! But the country faces relatively tougher market reaction to its political decisions. I have the feeling that investors somehow continue to blame the UK for its decision to quit the EU. But anyway, the selloff in gilts and the pound may have cooled down yesterday, but cost of boosting growth has become significantly more expensive for the UK government, meaning that we may not see the UK perform as well as it did last year. And that sets the pound outlook negative at the early weeks of the new year.

Moving on, the EURUSD continued to be sold in the absence of Americans yesterday and is trading below the 1.03 mark this morning. The selling pressure is backed by strong dovish expectations from the European Central Bank (ECB) that were – in return – backed by the French central bank head Francois Villeroy’s view that the ECB should cut its rates at every policy meeting into summer to reach a neutral rate. I doubt that his German equivalent shares the same opinion after inflation in Germany jumped to 2.9% last month…

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In all cases, the EURUSD’s – and other major pairs’ – short-term direction will likely be set by the US dollar. The US will release its latest jobs data today, and the numbers could help slowing the fast progress of the Federal Reserve (Fed) hawks that resulted – along with US debt worries – in rapidly rising yields.

Before the announcement of the US official jobs data, activity on Fed funds futures suggests that the Fed’s next rate cut should arrive in May – with around a 53% chance. A set of stronger-than-expected data could flip this expectation to the ‘no cut until June’ side very rapidly and enhance the selloff in the US dollar and support a further appreciation of the US dollar, while a set of softer-than-expected jobs data could strengthen the hope of a May cut. Given how quickly the Fed hawks have gained ground in recent weeks—and how much more investors are excited by dovish signals—the market’s reaction to soft data could outweigh its response to strong figures. The expectation is that the US economy may have added 164K new nonfarm jobs in December – well below the 227K added a month ago, but that number was boosted by the strikes and hurricanes of the month before (so the fall won’t be as bad as it first looks). Then, the average earnings is expected to remain highly sticky near the 4% on an annual basis – which is a problem for the Fed because people who earn more tend to spend more. And finally, the unemployment rate is seen steady near 4.2%. Again, strong NFP and wages growth would be supportive of the dollar, while soft NFP and wages growth should lead to a pullback in both. But if we see mixed figures, wages data could overweigh – unless we see an alarmingly high or low NFP figure.
Meanwhile in China

On the flip side of the world, the Chinese struggle with a completely different problem. Despite the announcement of multitude stimulus measures, yields there continue to dive, and the gap between the US and Chinese yields are widening *alarmingly*. We hear the phrase ‘Japanification of China’ pronounced very often since last year – the Japanification referring to inability to boost spending and investment despite lower rates. This – formally the liquidity trap – is probably the worse disease for an economy and takes very longtime to heal. The CSI 300 experienced its worst start to a year since 2016 and is finding difficult to rebound on low rates. The yuan is weak and the Chinese are expected to let it weaken further as an additional tool in the trade war against Trump. But low yields and prospects of a weaker yuan make it harder to convince foreign investors to bring on money, as the economic growth remains lacklustre. China will release its latest inflation report this weekend, and everyone prays for deflation to slow.