GBP: Vol Markets Signalling Significant GBP Vol Premium Into Budget
The pick-up in spot volatility this week has helped support implied at the margins, with the 1m contract (capturing the UK Autumn Budget on November 26th) rising back above 7 points to provide a decent premium over shorter-dated contracts that expire before the Budget.
While vols above 7 points look unimpressive in isolation, relative to EURUSD the move is extreme. The GBP 1m vol premium over EUR is now near 2 points and the widest since 2023 - signalling markets assigning a greater risk premium to GBP despite the background low vol regime.
We write on the latest expectations for the UK Budget in the Gilt Week Ahead here: https://media.marketnews.com/Gilt_Week_Ahead20251027_14ac41803e.pdf
And summarise the key drivers of GBP spot weakness here:
- Speculation that Reeves will break a manifesto pledge and raise income tax has been bolstered by the FT's reporting on a sizeable productivity estimate cut triggering a broader financing need.
- Higher income taxes would contain consumption, helping smooth the path for faster BoE rate cuts across 2026 (and potentially by the end of 2025).
- Food inflation remains a key driver of inflation expectations (e.g. Just this week: The Times: '‘Shrinkflation’ of supermarket staples rife on British high streets', BBC: 'Businesses face 'rising costs and staffing pressures''), however Tuesday's BRC-NIQ shop price data suggests we have passed the peak in food price gains.
- Food price inflation is particularly important given how well supported it has been this year via both higher employer's NIC contributions as well as incoming packaging taxes, but today's numbers endorse the step lower in ONS food inflation and may suggest inflation expectations will follow.
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US TSY FUTURES: CFTC CoT Shows Funds & Asset Mangers Trimming Exposure
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- Asset managers trimmed net longs in all contracts outside of FV futures, adding modestly to longs in the latter. This meant that the cohort trimmed its curve-wide net long position by $13.6mln DV01 equivalent but remained net long in all contracts.
- Leveraged funds covered net shorts in TU, FV & TY futures, while they added to shorts in UXY, US & WN futures at the margins. This meant that the cohort reduced their curve-wide net short exposure by $8.2mln DV01 equivalent but remained net short across the curve.
- Meanwhile, broader non-commercial accounts trimmed net shorts in TU, UXY, US & WN futures, while they added to net shorts in FV & TY futures. The cohort remains net short across the curve (see table below for more granular detail on non-commercial positioning).
Source: MNI - Market News/CFTC/Bloomberg Finance L.P.
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