‘Fire sale’ of UK assets as markets are spooked by mini-budget
Sterling is now tumbling against the euro too, as UK assets are hammered by the huge borrowing needed to fund the tax cuts announced today.
The pound has dropped by more than a euro cent to €1.132, its weakest level since February 2021.
Sterling is plumbing new depths against the dollar too – now down almost two cents at $1.106.
Neil Wilson of Markets.com says:
Sterling reacting with sub-optimal pessimism to the fiscal event with a fresh 37-year low with a 1.10 handle. And it’s not just a dollar move – see EURGBP.
The domestically-focused FTSE 250 share index has tumbled by 1.6% to its lowest since November 2020.
And government bonds continued to be hammered, as investors brace for the flood of debt sales to fund tax cuts and energy subsidies.
From the Debt Management Office – “The DMO’s Net Financing Requirement (NFR) for 2022-23 is rising by £72.4 billion to £234.1 billion following the publication today of the Government’s Growth Plan. “
— Ann Pettifor (@AnnPettifor) September 23, 2022
Wilson says there is a “fire sale of UK assets” which is “absolutely horrible to watch”.
The reaction in the bond market to the misnamed mini-Budget (it was anything but mini!) is striking with yields surging after the chancellor unveiled sweeping tax cuts that abandon any semblance of fiscal discipline. It means more borrowing and more borrowing costs. This is not the reaction any chancellor wants from a budget but what else could he expect?
Of course it’s not just vigilantism, per se – traders are now betting the fiscal easing will drive the Bank of England to take a much more forceful approach to tightening. Markets now indicate a 50% chance the BoE goes for a jumbo 100bps hike in November.
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Pound crashes as markets lost confidence in government
This is turning into an absolute rout on the pound, as the markets give a scathing verdict to Kwasi Kwarteng’s unfunded tax cuts and extra spending.
Having dropped through $1.10 earlier this afternoon, sterling has continued to crash….. all the way down to a new 37-year low of $1.09.
The pound has lost 3.5 cents today, cratering by 3% – on track for its worst day since the market panic of March 2020 when the pandemic hit.
Sterling has also fallen by two eurocents, to €1.1240 (the weakest in over 18 months).
Paul Dales of Capital Economics says the plunge in the pound, and in government bonds, shows that the markets don’t believe the mini-budget will deliver sustained, faster growth.
In a note titled “Kwarteng causes carnage”, Dales says:
The surge in gilt yields and the fall in the pound after the Chancellor announced his hefty tax cuts suggests that the markets have concluded the policies will lead to higher interest rates and more shaky public finances rather than a sustained period of faster real GDP growth. We agree.
While the fiscal loosening may make political sense, the size and timing of it doesn’t make much economic sense.
Investors are losing confidence in the UK government’s approach, warns JP Morgan analyst Allan Monks.
Markets expect [UK interest] rates to rise to over 5% – a reaction that cannot be explained by the mechanical impact of today’s fiscal easing alone, and instead reflects a broader loss of investor confidence in the government’s approach.
Monks has predicted that UK GDP will be 0.4% higher in the near-term as a result of the mini-budget, which he calls “a low return from such a costly and potentially risky package”.
Pound may tumble below $1 on ‘naive’ UK policies, warns former US Treasury secretary
Former Treasury Secretary Lawrence Summers has blasted the economic policies being adopted by Liz Truss, and warned that the pound tumble below parity against the US dollar.
Summers gave a blistering condemnation of the UK government, speaking on Bloomberg Television’s “Wall Street Week” with David Westin.
“It makes me very sorry to say, but I think the UK is behaving a bit like an emerging market turning itself into a submerging market.
“Between Brexit, how far the Bank of England got behind the curve and now these fiscal policies, I think Britain will be remembered for having pursuing the worst macroeconomic policies of any major country in a long time.”
Summers, who was Secretary of the US Treasury from 1999 to 2001, said he wouldn’t be surprised if the pound eventually gets below a dollar, if the current path is maintained.
He added:
This is simply not a moment for the kind of naïve, wishful thinking, supply-side economics that is being pursued in Britain.”
Liz Truss is choosing a markedly riskier path in a bid to revive growth, says George Lagarias, chief economist at Mazars.
Echoing the 1980s, the ‘Great British Pivot’ includes a mix of tax cuts, consumption and business boosting, de-regulation, union weakening and unemployment disincentives.
Whether it will succeed remains to be seen and the danger lies not in the course taken, but in the difficulty of implementation.
There are several factors that must be overcome for growth to take hold, he explains:
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The markets might not give Mr Kwarteng the time necessary for his plan to succeed. Traders, most of whom have never experienced such radical fiscal action in the UK, already reacted negatively. Two hours after the announcement, the Pound was losing 3% to the Dollar.
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Inflation could grow as the Pound loses ground. This could wipe out consumer savings from taxes.
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The Bank of England may decide to hike interest rates faster, to defend the Pound and stop imported inflation. Higher interest rates would mean that savings from taxes would end up being paid in higher mortgages.
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Global growth could continue to drop, affecting the demand for British exports and the prices for British imports.
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The de-regulation announced, as well as plans to prop up the British financial sector, could be hamstrung as Brexit negotiations which may determine access to European markets have yet to take place.”
Blanchflower: This is the economics of the madhouse
Economics professor Danny Blanchflower, former policymaker at the Bank of England, has condemned today’s mini-budget as the ‘economics of the madhouse’
Pound plunges below $1.11, FTSE 100 slides and UK bonds tumble as mini-budget spooks markets – enough said this is the economics of the madhouse
— Professor Danny Blanchflower economist & fisherman (@D_Blanchflower) September 23, 2022
Normally markets respond positively to a fiscal boost but not to this one that hurts ordinary people as they watch tax cuts to millionaires and city boys & they haven’t even costed it reckless
— Professor Danny Blanchflower economist & fisherman (@D_Blanchflower) September 23, 2022
Blanchflower fears the housing market is going to crash, as interest rates are hiked (possibly to 5% by next summer).
Three of the four markets collapsing next will be the housing market with sky high interest rates quantities first along with sentiment then 30% fall in prices next 18mths not inconceivable
— Professor Danny Blanchflower economist & fisherman (@D_Blanchflower) September 23, 2022
Kami-kwasi budget
— Professor Danny Blanchflower economist & fisherman (@D_Blanchflower) September 23, 2022
Pound has now fallen below $1.10
Angela Monaghan
The pound has fallen below $1.10 for the first time since 1985 as investors took fright at the prospect of a surge in government borrowing to pay for Kwasi Kwarteng’s sweeping tax cuts.
Sterling was down by more than two cents against the dollar to a fresh 37 year low as fears over the future path for the public finances also triggered a surge in government borrowing costs.
The FTSE 100 was down more than 2% at 6,989 while the FTSE 250, which includes more domestic-focused firms, also fell more than 2%.
The sharp sell-off followed a raft of tax cutting measures announced by the chancellor, in the biggest giveaway in 50 years. Measures included the scrapping of the top 45% rate of income tax, which currently applies to those earning more than £150,000 a year.
The plunge in the pound today means that poorest households are actually worse off, calculates Samuel Tombs, chief UK economist at Pantheon Macroeconomics.
That’s because they only get a few crumbs from the mini-budget (while high earners get a generous tax cut), while the fall in sterling will push up imported goods prices.
Low income households actually are *worse off* from the mini-Budget – they barely benefit from the tax cuts, but they will be hit hard by a rise in the cost of imports caused by ↓£. The current level of sterling points to a 0.5% boost to CPI inflation in 2024 from import prices: pic.twitter.com/xbUtHoc41S
— Samuel Tombs (@samueltombs) September 23, 2022
UK interest rates seen soaring over 5% by next summer
The money markets are now anticipating that UK interest rate could soar over 5% by next summer, due to the impact of the government’s tax cuts.
That’s more than twice their current level, even after the Bank of England’s half-point increase on Thursday, to 2.25%.
It would drive up the cost of variable mortgages sharply, and other forms of credit, hitting borrowers badly.
ING explain:
Bond holders are already rattled by inflation and by the prospect of more Bank of England (BoE) hikes. Even if the central bank hiked only 50bp yesterday, compared to market pricing of 75bp, markets are betting that the pace of hikes will have to accelerate.
The recent jump in yields implies that Bank Rate will peak next year well above 5%.
That in itself is not a great backdrop for bonds but what has rattled investors is the prospect of the BoE hiking more in response to generous fiscal policy.
100 bps increase on the cards for the UK
A one point increase will lift interest rates to 3.25%, according to interest rate swaps tied to meeting dates. Expectations are for borrowing costs to rise to over 5.5% next year which would still be below the last peak set in 2007.
— Max HarryHindsight Capital (@MaxDrake007) September 23, 2022
Anxiety about the cost of freezing energy bills is also hitting UK gilts (government debt).
Investors are worried the UK Treasury may have signed a blank cheque, because the cost of the guarantee depends how high gas and electricity prices remain.
ING’s Senior Rates Strategist Antoine Bouvet and Global Head of Markets Chris Turner, explain
Alongside the confirmation of additional borrowing this year, the raft of tax cuts unveiled today clearly implies that it will not be contained to just this fiscal year.
The cost of the newly-announced measures is reported to be £160bn over five years but, with the cost of the energy price guarantee highly dependent on wholesale energy prices, investors are worried the Treasury has effectively committed to open-ended borrowing.
For all Kwasi Kwarteng’s talk about getting growth up to 2.5%, the mini-budget may only deliver higher interest rates, and a higher national debt in the long term.
So warns Ruth Gregory of Capital Economics:
The Chancellor claimed that this was a plan for growth. But unless the Chancellor’s gamble pays off and the government’s fiscal policy boosts GDP growth by 0.5-1.0ppts per annum, the risk is that once the near-term boost to GDP fades, the legacy of the government’s fiscal plans will be higher interest rates and a higher public debt burden.
The market reaction, which included a jump in gilt yields, means higher borrowing costs are already here.
The cost of insuring Britain’s debt against a default has risen to its highest level since mid-2020 as concerns mounted about the government’s plans to slash taxes and ramp up spending, Reuters reports.
Here’s the details:
S&P global market intelligence data showed 5-year credit default swaps (CDS) – derivative instruments that debt investors typically use to hedge risk or bet against something – jumped 3.5 basis points to 34.5 points.
Such a large move is unusual for a G7 economy and it took the CDS level to its highest since mid-2020, when global markets were still in the most volatile stage of the Covid-19 crisis.
As the UK issues its own currency, it can’t ever be forced to default on its debt, though.
Bond market ‘completely spooked’ by Kwarteng
The bond market is ‘completely spooked’ by Kwasi Kwarteng’s mini-budget.
So warns Toby Nangle, former global head of asset allocation at Columbia Threadneedle.
He has shown how today’s surge in five-year gilt yields (as bond prices have slumped) is worse than in any crisis since 1993.
Really hard to overstate the degree to which the Kwarteng Budget has just wrecked the Gilt market.
Chart shows 20 day change in 5yr fixed rate yields since 1993. Market completely spooked. pic.twitter.com/cQSOPqAclc
— Toby Nangle (@toby_n) September 23, 2022
Pound parity suddenly looks more likely following the mini-budget, says Fiona Cincotta, Senior Financial Markets Analyst at City Index.
Far from soothing concerns over the outlook for the UK economy, Liz Truss and Kwasi Kwarteng’s economic plan for the UK has sent the pound plunging. The announcement of the largest tax cuts since 1972 to boost growth and stave off a recession that has already started, has triggered a crash in the pound and the bond market.
The selloff in UK assets reflects the sheer panic as the new government’s stimulus package will not only grow an already sizeable debt burden, potentially to unmanageable levels but will also add to inflationary pressures.
The BoE, which has been reluctant to hike rates aggressively, will need to roll up its sleeves and fight inflation with larger rate hikes for here. Expectations for a 1% hike in November are already climbing.
It’s difficult to see how the pound can recover from here. Investors are pulling out of UK assets rapidly and who can blame them? Drawing comparisons historically, the last big tax giveaway in 1972 resulted in rampant inflation, unmanageable debt, and an IMF bailout.
Suddenly pound parity with the USD doesn’t look so unlikely.
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