UK gilts have stabilized after a recent selloff, with 10-year yields dropping by nearly 9 basis points to 4.52%. Concerns about the UK’s fiscal direction, especially regarding Rachel Reeves, fueled the earlier selloff. During Prime Minister’s Questions, Reeves faced tough questioning, leading to emotional moments and prompting PM Starmer to publicly support her. Starmer emphasized his full support for Reeves and highlighted the need to follow fiscal rules. It’s still unclear if this is the best policy for the UK. However, it seems to have avoided a crisis similar to last year’s Truss mini-budget. The British pound remains steady, trading at 1.3655. Gilts seem to have regained some stability, as the recent yield drop indicates less immediate pressure from bond markets. The nearly 9 basis point decrease in 10-year yields shows a shift in sentiment after the selling wave tied to doubts about the UK’s fiscal direction. Reeves was under intense scrutiny, with opposition members questioning her spending plans and her commitment to financial rules. The heated debate heightened uncertainty among market participants. Although Starmer didn’t address policy directly, his support suggested an intention to maintain market confidence, despite the loud criticism. His call for fiscal discipline was aimed not only at political watchers but also the financial community. While Starmer’s assurances don’t guarantee calm in the market, recent movements in gilts indicate that investors are currently accepting a commitment to rules-based management. However, any signs of a shift from this message could reignite volatility, especially with last year’s rapid surge in yields still fresh in their minds. On the currency front, the pound shows much more stability than long-term bonds, holding steady at 1.3655 against the dollar. This level reflects balanced market expectations. Currently, there are no troubling signals from the FX markets, which usually react swiftly if fiscal policy seems inconsistent. However, currency traders should remain alert, as these markets often serve as early warning signals for declining confidence. From a trading perspective, the short-term movement of derivatives related to interest rates and currencies will largely depend on any changes to the current fiscal messaging. Additionally, there is heightened interest in upcoming announcements from Treasury and central bank officials. Even minor deviations may cause significant shifts in expectations if policymakers appear divided or unclear. Volatility projections for interest rate products have eased but remain elevated compared to year-to-date averages. This indicates that many market participants are keeping options open through swaps and options, anticipating that clarity on fiscal plans may not last long. Therefore, we prefer strategies that allow for potential tail-risk moves in gilts, especially in longer maturities where sentiment has been fragile. Flows are currently favoring gilts, particularly in the 10-year sector. However, the consistency of these flows will be crucial moving forward. If buying appears forced—more about technicalities than genuine belief—the market could respond unevenly. Spreads between UK and German yields remain wider than usual, suggesting a lingering risk premium. This reflects cautious optimism at best. Meanwhile, forward curves in sterling swap markets indicate expectations of fewer rate hikes from the Bank of England. Risk appetite is still subdued. Positioning data shows only modest inflows into leveraged interest rate products, indicating that widespread confidence in a stable fiscal narrative is lacking. There may be opportunities for tactical entrants, but managing downside risk will be essential. Looking ahead, attention is on the upcoming Autumn Statement. Any divergence between the stated intentions and the budget details should be monitored closely. Based on past reactions, fiscal uncertainty will likely trigger rapid changes in long-term derivatives pricing. For now, we are treating any increased exposure as tactical and continue to hedge on duration.

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