Carnage.
That’s the best one-word description of the market revolt unleashed by Liz Truss and her Chancellor of the Exchequer, Kwasi Kwarteng, who, during ill-advised remarks to the media, doubled down on the tax cut pledge that triggered the worst session for UK bonds in modern history.
“We’re bringing forward the cut in the basic rate and there’s more to come,” he told the BBC’s “Sunday with Laura Kuenssberg” program.
That presaged “more to come” in the way of pain for gilts and the pound, which fell to a record on Monday. At the lows, sterling traded around 1.03, the lowest since decimalization (figure below).
The initial gap move in Asian trading was attributed to low liquidity, and the pound did manage to pare losses, but ultimately, the Bank of England will need to resort to an emergency rate hike to stabilize the currency.
At the least, Andrew Bailey needs to reassure markets this week, even if the optics of speaking publicly about the currency would be poor for Truss. The BoE’s forecasts, as released last month, are completely out the window now. That in itself is a sufficient excuse for Bailey to engage the public.
The market now sees rates peaking above 6% next year. Markets priced a 25bps hike today. There was some speculation that the BoE would hike more than 150bps through the November meeting.
The UK’s Debt Management Office intends to lift gilt issuance by more than £62 billion. That, as the BoE actively trims its own holdings by £80 billion over 12 months. On Monday, UK bonds tumbled again. Five-year yields rose another 50bps. That makes one full percentage point in two sessions (figure below).
Two-year gilts were 60bps cheaper. 10-year yields, which rose the most ever on Friday, jumped another 30bps to start the week. So, it was possible that 10-year UK bonds would suffer their two worst days on record back to back.
Again, that’s carnage. Beyond that one word, it’s difficult to find the right adjectives to convey the scope of the peril. Rate differentials no longer matter for the pound. Rescuing the currency either means hiking rates, preferably right now, or else liquidating reserves.
The UK curve will probably continue to pancake, but then again, there’s a very real risk that UK debt becomes uninvestable. As one Bloomberg blogger put it on the terminal, “the risk is, of course, a complete repudiation of UK government debt.”
Rachel Reeves called Truss and Kwarteng “two desperate gamblers in a casino chasing a losing run.” “They’ve lost credibility, they’re losing confidence, they’re out of control,” she said.
The Fed and the US Treasury will absolutely be on the phone with the BoE today. Over the past week or two, I’ve repeatedly suggested Jerome Powell and Janet Yellen will be compelled to coordinate with central bank governors and finance ministers across the developed world to put a stop to the dollar’s run higher. That imperative became more urgent Monday.
So I guess it was possible to find someone more feckless than Boris.
This is, potentially anyway, one of the worst situations I’ve ever seen.
I had the same thought… 🙂
Conservatives everywhere are a menace but I didn’t realise how true that was in the UK case… 🙂
After decades of QE, politicians has forgotten about fiscal credibility.
Feels like emerging market, falling FX, bonds, possible emergency rate hike and market pushing for austerity measure in a recession.
Having said that, my stay in Edinburgh is becoming more affordable by the minute.
I guess Sam Brownback has moved to Britain.
“ I’ve repeatedly suggested Jerome Powell and Janet Yellen will be compelled to coordinate with central bank governors and finance ministers across the developed world to put a stop to the dollar’s run higher. That imperative became more urgent Monday.”
The Fed and Treasury have often been late in these types of coordinated efforts waiting until it was absolutely necessary after significant pain was felt. I don’t think we’ve reached that point yet as the Fed especially is “distracted” with its inflation fight.
As usually H is right, but I doubt the Fed and Treasury are read to follow his prudent advice.
I dunno, a simultaneous move down in both the currency and the bond market is a pretty huge warning sign. This is beyond Red Flag, and well into Air Raid Siren Warning Klaxon territory. Sure, the powers that be have a lot on their plate, but I doubt they’ll be too distracted to respond. These are the kind of moves that quickly lead to contagion, and that’s the kind of risk Yellen should be all over.
To the tune of Simon & Garfunkel’s “Sound of Silence”:
Hello margin call old friend
The futures market broke again…
I believe you’re correct, Hopium, about JP and Yellen being compelled to work together. They really will have to do so. But will it actually help? And if so, how quickly?
The world economy is already being chilled by the war between Russia and Ukraine, which also is impacting oil markets. The UK crisis is just one example of the domino effects that may possibly be triggered in other world economies by the Fed’s response to US inflation. Any way it goes, I reckon global economic recovery will be a long time coming.
Why would the US be panicked?
Stronger USD helps the US right now.
I understand that a RoW crisis represents a risk to US growth but I’m not convinced US officials are in charity mode just yet.
“Why would the US be panicked?”
Not that Powell and Yellen have a problem with a strong dollar right now, they have a problem with contagion risk in the event that market volatility swings out of control. Orderly functioning of markets is very important in a capitalist society, and contagion from cascading margin calls benefits no one.
I would point to the example from 1998: the East Asian currency crisis (a.k.a. “The Asian Contagion”). Then FED chair Greenspan, along with Sec. Treas. Rubin (plus his deputy, the redoubtable Larry Summers), responded with a massive injection of liquidity into global markets. This made orderly posting of margins and settling of markets possible, heading off what could have been a financial calamity.
Completely agree with that – even domestically, the only “Fed put” in markets right now is if they become disorderly.
BUT, I’m not convinced we’re close to global contagion yet.
Yes, currencies are under pressure across the globe.
Yes, USD strength hurts others.
But, there are good reasons why the USD is outperforming , the US wants a stronger USD, and until we see a large economy on the risk of USD default, i think we are still in the “our currency, your problem” phase.
The US can just doll out swap lines to allies as it did in February 2020 – although remember then the US was worried about deflation and didn’t want a strong USD. Now, the US does want a strong USD. But I wouldn’t call swap lines “global coordination”.
Post imperial Commonwealth Britain seemed like it was becoming a big worldwide tax haven to me. Britain exit being a part of that. If so, now is not a good time to be so obvious about it.
This is a final nail in the coffin for the Tories. Expect an election disaster for them in 2024. No more leveling up there and the standard of living will be taking another gigantic hit in great britain
as long as all those immigrants and euro bureaucrats that were making life impossible are gone… 🙂
I wonder about the odds on a no-confidence vote on Truss in coming weeks? I am not sure what the potential fiscal risk is from her unfunded energy bill cap plus her tax cut, but my guess is we’re looking at potentially $200BN ($100BN household energy, $50BN business energy, $50BN tax cuts) or 8% of GDP. How many Tories voting for Truss were asking for that size fiscal hole to be instantly blown in the UK budget?
Panic sell until central bank panic!
This brings me back to the January question :
What will 2020 be remembered for ? Answer is Fiscal Disaster , Geopolitical Disaster and likely Environmental Disaster …Pretty grim prospects out there and a more realistic tone earlier on could have avoided some of this …
And now let’s see what Italy’s new government will do . . .
US looks even more like best house in the neighborhood. Money flow to US assets, initially to USD and short duration UST, then when Fed transitions from “raising” to “holding” is in sight, will flip over to risk and duration assets. Presumably Fed will make that transition at some point, likely 1H23, partly due to long and uncertain lag of monetary policy effects, and partly in response to global financial stress. Wouldn’t it be interesting if the “Fed will pivot when it breaks something” predictions come true, but that “something” is not in the US and parochial US investors go “shrug”.
China could also look like a better house post-coronation, depending on the Imperial Xi’s policies.
Just my speculation.
Don’t worry too much about Italy. Since 1945, there have been 69 different governments in 77 years! The average age has of each been 1.11 years. Not really a great job is being the boss in Italy. I would guess the main Mafia dons have lasted longer.