All eyes on the UK as we lead up to Payrolls

There is a packed calendar today, as US payrolls are released a day early due to  US markets being closed on Friday for the 4^th July holiday. Usually, payrolls would be the main story, however, after Wednesday’s rout in the UK bond market on the back of the welfare reform bill, UK assets will also be watched closely.

UK Gilt yields surged on Wednesday, and the pound sank, as the markets fretted about the possible sacking of the UK Chancellor, after the Prime Minister failed to back Rachel Reeves during a bruising Prime Minister’s questions.  But Rachel Reeves can wipe her tears, as she has the backing of the bond market. Far from weakening her position, the surge in bond yields is a warning to the PM and the Labour Party as a whole. The market does not want to see a more left-leaning Chancellor in place, and Reeves is about as ‘market-friendly’ a Chancellor as the Labour Party can hope for.

The bond market has harsh lessons in store for the Labour left

The bond market has reminded the hard left of the Labour party that the UK economy cannot afford its benefits bill. Part of the move higher in yields was also generated by concerns about what is in store for the Budget in the Autumn. After the watered down welfare reform bill, the focus was on the need to raise taxes and to potentially issue more borrowing to cover the cost of Labour’s plans. However, the bond market revolt suggests that these two options are not viable when national debt is so high and the economy is so weak. The bond market is telling the Chancellor to get on with the job of reducing unsustainable levels of public sector spending, but will she listen?  

UK Gilt yields backed off from their highs late on Wednesday, after the Prime Minister supported Rachel Reeves’ position, however, 10-year Gilt yields still closed up 15bps. The 30-year rose by nearly 20bps. Today will be a test, will yields reverse these gains now that we have assurances Rachel Reeves will stay in position, or will yields continue to rise on the back of fears that the hard left will force the PM into bosting spending and raising taxes? Today, could be a make-or-break moment.

Bond market volatility is becoming a theme for the UK

Yesterday’s move in Gilt yields was large, and on par with 2022 spikes higher in the 10-year and the 30-year yield. However, a theme is emerging, since 2022 we have seen more frequent spikes higher in UK yields, which is a feature of the UK bond market since Covid. This is likely to continue until debt levels come down and public sector spending rates return to pre-covid norms.

The pound stages a partial comeback

The pound is higher today, although it remains the weakest currency in the G10 FX space so far in July. GBP/USD has drifted higher in the Asia session and has retraced nearly 50% of Wednesday’s losses. The tensions at the top of the UK government has caused excess volatility in the pound; after falling dramatically on Wednesday, it is now the top performer in the G10 FX space early on Thursday.

Payrolls preview

US stock markets made a fresh record high on Wednesday as we lead up to today’s payrolls report. The market is expecting a reading of 106k for last month, and the unemployment rate is expected to inch up to 4.3%, which would be the highest rate since 2021. Average hourly earnings are expected to fall a notch to 3.8%, and initial jobless claims are expected to rise. A negative ADP private sector payrolls report did not spook the stock market on Wednesday, and expectations for a Fed interest rate cut rose slightly to 25% from 20%. The ADP does not have a great correlation with the NFP report, however, a weak jobs reading for June, which is less than 100k, could see the market step up rate cut expectations for the US, which may weigh on the dollar, and trigger lower Treasury yields.

Overall, the focus is on the UK this morning, before it switches to the US. We expect a cautious tone to markets today, although the dollar is higher against most G10 currencies, and S&P 500 futures are also pointing to a higher open later today.