Global FX: GBP FX - UK Budget Preview

(upbeat music) - Hello, welcome to this week's At Any Rape podcast. My name's Pat Locke, FX Strategy based out in New York. With me today, James Nelligan out of London to talk about one of the more highly anticipated macro risk events this year, the UK budget, which headlines what looks like a pretty loaded event risk week next week across the DM space. James, you've had a pretty good call on sterling this year, fading the spike in risk premium in Euro sterling early on in Barnum's Premiership campaign. And lo and behold, sterling's proven to be the third best performing currency so far this year in G10 as a result. But now you could say the moment of truth has arrived with the budget due to be announced next week on the 28th. And so having faded sterling's fiscal risk premium earlier this year, how are you now seeing the risks around the budget release itself for sterling next week? Thanks, Patrick, yeah. I think communication around this throughout the year has been the new leadership looking for a kind of fiscally neutral budget, recognising the fiscal constraints and talking about sticking to the fiscal rules. I think that's something the market's very comfortable with. And in terms of our expectations, we've kind of narrowed down on a buildup of around 15 billion of headroom, which we get to via around kind of five billion of tax raise measures. There's been some guidance around what the make up around that would be in terms of potential bank tax where the surcharge be raised from 3% to 8% might raise as much as $2 billion a year. And I think that kind of base case for sterling, if you're getting 15 billion headroom, the tax measures are reasonably close to what's been discussed. Then you could look for some rally on sterling on the day. We've set around half a percent. Maybe that's a bit much considering the news itself, because I think the market has centred on that kind of outcome already. And sterling's been rallying on that idea, the reduction in fiscal risk premium. So for me, it's more about a clearing of event risk and getting past the uncertainty, which just allows parts of the market, which maybe were a bit uncertain or even short sterling, to kind of embrace sterling carry. And we saw a similar dynamic when Starmer stepped down in July. And we saw that again when the chancellor was appointed later that month in the sense that it wasn't necessarily the candidates. It was more about the reduction in political uncertainty allowing the market to embrace carry. And that's how I'm seeing the budget event itself in terms of how it stacks up for sterling if you get a base case outcome. But obviously, there are other outcomes. I think if we slip the low 10 billion headroom, that's optically difficult for the market. That might prompt a little bit of weakness in sterling. If the tax measures are a bit harsh, there if you go well above 8% on the bank surcharge, that could also hurt sterling a little bit. So I want to press you here, actually. So devil's advocate would tell you, the market seems pretty complacent around the risk here. It seems to me like everyone's kind of converged around these headroom estimates, 10 to 15, which are still pretty small in absolute terms and relative to past budgets. Barnum made some pretty big campaign pledges early on. Now, energy prices are back up and theories should continue to squeeze headroom further. And communication, you say, has been pretty airtight, maybe outside the bank tax statement last week. So is the market actually underestimating risks of surprises here, either on the tax side or on the spending side? And how are you thinking about the tails here for sterling? - Yeah, I think you're right. It does create bearish skew in the sense that the market has centered on a fiscally neutral outcome in the budget for such a long time. You know, the reaction would be larger if you see a disappointment. So, you know, if you get, if headroom falls well below 10 billion and you get kind of excessive unfunded spending and you know, the market is baking in baking fiscal risk premium back in. You know, I think on the day you could see say Euro sterling 75 basis points higher as opposed to say a kind of 25 to 50 basis point fall in Euro sterling on a base case outcome. So that's the kind of skew we're thinking about. But, you know, I would say that there are kind of modest disappointments that the market can handle and digest. And I think the difference this time is that there's much less of the doom loop now for sterling compared to last year where growth was being revised down last year that meant that as yields rose, you know, that was impacting headroom on a, you know, day by day basis and making, you know, creating that doom loop that kind of vicious cycle where, you know, you had to raise tax by more to build up the headroom. Whereas, whereas this time, I mean, our economists has got a few three growth running at 2% annualized, which and our forecast revisions for the UK are at multi-year highs. So it allows, it's much more digestible now in terms of the tax rise for sterling. And that means that, you know, if we do get a headroom that's say modestly below 10 billion or you get 10 to 15 billion headroom and say, you know, that the bank surcharge is above 8%. Then I think, you know, initial weakness on sterling on the reaction can be faded and the market will end up buying the dip in sterling and it might not finish up on the day, but it probably would finish up on the week, I'd say. - Yeah, maybe that's a good segue. I mean, we've had a couple seemingly material development in the UK macro side this week, inflation layer market, seeming to galvanize some sterling buying, you know, across discretionary funds. You know, are you leaning into that? And I know you've mentioned Brexit before recently. I mean, what do you think about the skewer risks to sterling kind of like setting aside the budget here for a moment, like what's, what's kind of the main macro outlook going forward for you? - Yeah, I think I thought the day to this week was super interesting in the sense that, you know, we've got 4.7 on the unemployment rate. Okay, we've got a kind of marginally sticky CPI print, but you know, Bank of England has the unemployment rate going back above 5%. So they're starting to look a bit offside here as we come into the November meeting. And the interesting thing on that from a sterling perspective is we see the rally this year is kind of more about fiscal risk premium, maybe some Brexit risk premium creeping in, as you say, carry positioning growth, but really front-end rate spreads have taken a bit of a back seat and they've been more something that has held valuations back as the market's seen what's gone on as more of a kind of synchronized hiking cycle across the end. And, you know, you look at the way the rate spreads behaving. Now, maybe there's a narrative starting to creep in. Okay, could the Bank of England start to outpace the ECB? That would just, that would give an extra angle to valuations in terms of, okay, you're a sterling two-penced cheap on an 83 handle now, but if front-end rate spreads start to move, then that opens up, you know, if you're still two-penced cheap, you can creep onto an 82 handle potentially. So that's interesting. I think in terms of the way the data's evolving. As you say, Brexit, we've got the EU summit in November. You know, there is, there is a line of thinking where the budget is now actually a little bit boring and this is now the new issue in terms of it being a policy goal and the signaling value that comes out of the summit could be quite important for sterling, which has spoken before about potential 7 to 12% risk premium in the trade-weighted index for sterling that is not going to disappear completely straight away, but the market can kind of chip away at. And I think if you come out of the summit with signaling value around issues like student education or youth mobility or recognition of professional qualifications, these are all issues that have been discussed before and our economists believes, you know, could provide some to wiggle room in terms of signaling value that I think that could be important for sterling. And I think finally, something that's really stood out to me is the positioning angle. And Pat, I wanted to turn to you on that. CFTC positioning for sterling back to all times shorts. How does that square? with your positioning data, and is there anything else to flag on positioning? Yeah, well, you know, for starters, it certainly doesn't square with intuition, right, given kind of the relative out performance and drilling and some reasonably decent data performance over some time. And, you know, looking at kind of our other metrics, it would suggest that maybe drilling isn't quite as short as what the futures would say. So our options flow data would suggest actually cables a little bit, probably flatish on positioning. And similarly in options, euro-strialing is actually turned modestly, net short. So I think, you know, looking squarely at futures following exaggerates the extent of the positioning. But obviously at the same time, you can't dismiss that trading sector, right? It does tend to reflect CTAs and momentum followers. And so I've been describing it as pockets of drilling, you know, short still exist. And as in when you pass through event risk like next week and use it as a market clearing event, like you said, it wouldn't be surprising to me to start to see some of those positions get covered, especially as the broader carry trade around which futures traders have been, you know, highly concentrated and oriented around. So the better part of the last year or so continues to come under pressure with things like Max, you know, we're seeing in the futures data, you know, the centricity of the carry trade is actually starting to add. So maybe that also provides something of an impetus for that particular sector to cover remaining drilling short. So I think that's possible. I don't think we're looking at like a two sigma unwind across like the broader discretionary and macro community. Again, options aren't signaling that. But I do think there's probably some scope there to do it. And I think, you know, also, euro-strolling can probably continue to trend lower where I do think, you know, positioning is reasonably crowded on my metrics is in euro kind of across the board. You know, euro dollar position kind of like in that one and a half to two standard deviation range and a lot of euro-crossed is following suit. But I don't get the sense that euro-strolling in particular is a very crowded short amongst the euro-crosses. I think it's probably more confined to things like euro-azzy and the likes there. So that's another opportunity where maybe you don't get like a positioning unwind tailwind. But, you know, positioning itself is not obviously a headwind to further euro-strolling losses. So yeah, broadly, I think, you know, modest short and some and some kind of pockets or squares of the, of the positioning community, but room to extend, probably sterling length on the whole. Thanks, yeah. I mean, you know, just kind of dreaming for a second if I, if I may. I mean, that CFTC number is really quite striking to me and, you know, I agree, Patrick, you know, there is reason to be skeptical. And we've seen this with, you know, for example, Euro-CFTC positioning data in the past that it hasn't, you know, that there are ways you can look at it that tell you it's not probably it's not giving you the cleanest read. But if there is any element of truth in that, just kind of thinking, broader, longer picture, kind of six-month horizon for a second, you know, if you do, if the budget is a clearing event and that positioning does start to reduce in terms of the short positioning and, and this theme around European politics stays with us up to the French election and Euro-Dollar starts to perhaps trade cheek-to-fair value like, like Mira has been been talking about, you know, there's potential for a fairly size Euro sterling downside move I'd say from here, you know, even after what we've seen, potentially the low 80s or maybe even a seven-hand or just, if I may speculatively for a second, I do think it's a really interesting setup. And I do think, you know, it's important to kind of zoom out on that chart and look at some of the levels that we were trading at in Euro-Sturling pre-Brexit and try and think about, you know, the themes that we have now in terms of French bread widening, et cetera, the persistence of Carrie and where that could take us in terms of sterling. But yeah, we'll leave it there and thanks, thanks for joining Patrick, thanks everyone for listening. This communication is provided for information purposes only. Please refer to JP Morgan researcher reports related to its content for more information, including important disclosures. 2026 JP Morgan Chase Company all rights reserved. This episode was recorded on October 21st, 2026.