GBP/USD fell to about 1.3415 in Asian trading on Tuesday. The pound eased against the US dollar as UK politics stayed unsettled, with traders watching the UK employment report due later on Tuesday.
Prime Minister Keir Starmer faced a leadership crisis after weak local election results on 7 May. This was followed by senior resignations and market volatility, while UK gilt yields rose to a 28-year high amid fiscal concerns.
Uk Growth Outlook And Political Uncertainty
The IMF raised its UK growth forecast for this year on Monday. It also warned that domestic uncertainty linked to political instability could reduce spending and investment.
In the US, stronger-than-expected inflation supported a more hawkish Federal Reserve stance and lifted the dollar. Fed funds futures price in a 35.0% chance of a 25 basis point rate rise by year-end, based on the CME FedWatch tool.
Given the political instability in the UK, we believe the path of least resistance for GBP/USD is downwards. The combination of government resignations and fiscal worries is creating a toxic environment for the pound. We should be looking to establish short positions, with put options being a straightforward way to express a bearish view while capping potential losses.
We are seeing UK 10-year gilt yields push towards 5.5%, a level unseen since 1998, which is injecting significant volatility into currency markets. This makes buying options expensive, so we should favour strategies like bear put spreads to lower the entry cost. This approach would profit from a steady grind lower towards the 1.3200 psychological level over the next few weeks.
Key Near Term Catalyst And Volatility Risk
The UK employment report due today is the immediate catalyst; a soft number will almost certainly push the pair lower. Meanwhile, with recent US inflation data showing core CPI holding stubbornly around 3.6%, the dollar’s strength is well-supported. We must keep an eye on the FedWatch tool, as any increase in rate hike probabilities above the current 35% will add fuel to the fire.
This market environment is reminiscent of the fiscal shocks we saw in previous years, where a crisis of confidence in UK policy caused extreme price swings. During that period, 1-month implied volatility for cable jumped above 20%, highlighting the risk of being on the wrong side of sharp moves. We must therefore respect that this political risk premium can keep the market volatile and unpredictable.
