Insights 
VT 
Recently, the forex market has focused on the sustainability of G10 countries’ debt. France is under scrutiny due to its budgetary challenges, although this issue affects other countries, including the UK, with an impending budget announcement. The US Congressional Budget Office reported a projected deficit of $1.8 trillion this year, drawing attention to fiscal matters.
Impact of Public Debt on Exchange Rates
Exchange rates are impacted as public debt in G10 countries gains more interest from the market. Previously, the link between spending and growth was evident, as countries spending more during the pandemic experienced greater growth. This connection influences currencies through growth, allowing central banks to concentrate on inflation and monetary policies, benefiting the currency.
Deficits remain high with limited management, and spending does not always drive growth. In the US, despite high deficits, the economy is weakening, impacting the Fed’s monetary policies. Stability is essential for the forex market, and fiscal disputes among Western governments may continue to garner attention. The concern over the UK’s upcoming budget reflects market anxiety, representing broader fiscal challenges in G10 countries.
In recent weeks, we have seen the market’s focus shift dramatically to government debt sustainability. The old assumption that high spending automatically leads to strong growth is breaking down. For example, the CBO’s final numbers for fiscal year 2025 confirmed a US deficit of $1.95 trillion, yet recent data showed Q3 GDP growth slowing to just 0.8%.
This change has direct implications for the US dollar and Federal Reserve policy. With the economy weakening despite record deficits, the Fed may have less room to maintain a restrictive stance. The futures market is already pricing in a 60% probability of a rate cut by the end of Q1 2026, which could pressure the dollar.
Fiscal Anxiety in the United Kingdom
Across the Atlantic, we are seeing similar fiscal anxiety building in the United Kingdom ahead of its late November budget announcement. This nervousness is clear in the options market, where one-month implied volatility on GBP/USD has climbed above 12%. This brings back memories of the instability we witnessed back in 2022 and suggests traders should prepare for significant price swings.
This is not just a UK issue, as political challenges in France over its own budget have also unsettled markets. The spread between French and German 10-year government bonds has widened to 85 basis points, signaling rising risk perception. This backdrop of fiscal strain across major European economies suggests potential weakness for the euro.
For derivative traders, the takeaway is that fiscal policy is now a primary driver of currency volatility. Strategies that worked when central banks were the only story may no longer be effective. It seems the period of betting on low volatility is over, and it is now prudent to consider positions that benefit from price instability, such as long volatility plays on the pound or dollar.
