FED: US TSY 17W BILL AUCTION: HIGH 3.610%(ALLOT 28.83%)

PM Sir Keir Starmer has said that the UK will "need to go faster" on increasing defence spending at speed amid an increasingly unstable geopolitical risk environment. The BBC reported overnight that the gov't was looking at proposals to increase military spending to 3% of GDP by the end of the current parliament in 2029. This would be a marked shift from the current stated target of 2.5% of GDP by 2029, with the "ambition" of hitting 3% in the next parliament. 

• While the UK is one of the largest military spenders in NATO in dollar terms, perceptions of a slow crawl from the UK gov't to the '3.5%+1.5%' target agreed to at last year's NATO summit had raised eyebrows.
• The OBR projects the increase would cost an additional GBP17.3bln/year, while the IFS puts the figure around GBP13-14bln. This would require the gov't to break its manifesto commitment and increase income tax/NICs/VAT. These costs could make an acceleration a non-starter.
• The gov't is facing pressure from the armed forces, military experts, and the US to hit the spending targets sooner rather than later. However, Starmer faces the likelihood of Labour backbenchers arguing that money would be better spent on the NHS, welfare or other areas of public expenditure.
• It is unclear if Starmer has the political capital for such a move. Moreover, if the PM is ousted in the next few months, the chances of any of the frontrunners from the soft left of the party following through with the acceleration plan are very low given that wing of the party's more overt focus on domestic state spending.

The ‘sell America’ idea, which is partly based on the erosion of U.S institutional independence, continues to form the centrepiece of many macro discussions.

• The latest Bank of America survey revealed that “following the nomination of Warsh as the new Fed chief, worries regarding Fed independence has meaningfully abated. However, it did not translate into greater demand for the dollar nor renewed optimism on U.S. assets. Investors' exposure to the USD broke the lows from April ‘25 and reached levels not previously recorded within our time sample (starting Jan ‘12)”.
• They go on to highlight that “most now prefer to either increase their FX hedge ratios or reduce their exposures to U.S. assets. Lastly, the belief of a continued reduction in USD holdings amongst reserve managers grew stronger, and a larger share now expect an increased pace of rebalancing. It should be noted however, that most responses were given before the publication of the recent U.S. jobs report, which might ease some of the bearishness - especially as U.S. data resilience and Fed repricing is seen as the primary near-term tailwinds for the USD”.
• Cross-market, the survey revealed that “long core EU vs U.S. duration exposure reached '13 highs”.

The downtick in equities provides some background support for gilts, but futures remain within the pre-existing session boundaries.

• Session highs located at 92.02, shielding the January 22 high (92.13).
• Yields ~2bp lower across the curve.
• 10s once again near uptrend support (4.381%). A break there would target the year-to-date low (4.336%).
• Earlier headline flow surrounding expedited UK defence spending does little, partly owing to the increased political uncertainty in the UK.
• Recent headlines noting that the government abandons plans to cancel 30 local elections in England (see recent bullet from our political risk team for more) also do little for markets, but potentially increase the odds of a Labour leadership challenge
• GBP STIRs remain unable to fully discount 50bp of further cuts for the current cycle.
• ~18bp of easing priced into BoE-dated OIS for March, 24bp through April, 33bp through June and 48bp through year-end. Markets are unable to fully discount 50bp of additional easing for the current cycle at this stage.
• SONIA futures flat to +2.5, SFIZ6 still respects pre-existing year-to-date highs (96.750).
• UK labour market data is due tomorrow, with CPI due Wednesday (expect our full preview shortly).
• Market expectations are roughly attuned to BoE forecasts for labour market data. We think pricing for a March cut will increase further if the data is broadly in line,
• UK CPI is expected to move lower in January, with the February MPR looking for a print of +2.9% Y/Y and the BBG consensus looking for +3.0% Y/Y.