The new week comes as the market sell-off continues after the UK government announced its fiscal plan, with Prime Minister Liz Truss’ government just a few days into office under intense pressure.
On September 23, British Chancellor of the Exchequer Quasi Kwarten launched a desperate tax cut and additional borrowing plan to stimulate the economy. Investors reacted violently and extremely negatively, and British assets plummeted. Over the weekend, Kwasey promised further tax cuts, seemingly unconcerned by the market’s reaction.
The decline barely waned when Asian markets opened on Sept. 26, with the beleaguered pound hitting a fresh 37-year low against the dollar. If traders continue to feedback market sentiment in real time this week, the decline will continue to deepen, and the risk of selling may not only lead to short-term embarrassment for the government, but a more serious crisis, and the policy must respond quickly.
The British pound fell as much as 0.9% on the evening of September 25, falling below $1.08, so the British government bond market at 8 am on September 26 is also worthy of attention.
“The pound is likely to weaken further as widespread private spending in the fiscal sector fails to match monetary policy to offset inflationary impulses,” Goldman Sachs analysts including Carmackia Treveld said on Sept. 23. in a report sent to clients.
September 23rd came close to being the worst day for the pound against the dollar since the record collapse following the Brexit vote in 2016, a testament to the severity of its history. It closed down 3.6%, the seventh-biggest drop in the past 50 years. Meanwhile, government bond yields have soared, with some durations hitting records, as investors punish the chancellor for growth without remorse.
If the current situation persists, higher yields will significantly increase borrowing costs, as the Resolution Foundation, a British think tank, estimates that its plans over the next five years will require an additional 400 billion pounds ($434 billion) in borrowing. At the same time, the interest bill has ballooned because of stubbornly high inflation and the Bank of England raising interest rates.
Last week’s market moves could have a huge impact. The Daily Telegraph (The Telegraph) said on September 24 that if the pound fell to the equivalent of the dollar, Truss’ tax cut policy would face opposition from the Conservative backbenchers. At the same time, some market players have called for the Bank of England to take urgent action to curb the trend of sterling depreciation, after all, the sterling is so low in contemporary times, which may increase panic.
Former Bank of England official Adam Posen said on Twitter that Governor Andrew Bailey of the Bank of England is expected to “publicly say by mid-week that if sterling falls, interest rates will rise.” He also mentioned It is possible that the Treasury will intervene in the pound before the market opens on September 25, but others pointed out that the UK has much less foreign exchange reserves than countries such as Japan, which have followed the same policies.
If the market can calm down a bit over the weekend and the pullback starts on Sept. 26, it could buy Truss and Kwarten some time to get back on the agenda. The Conservative Party conference in early October, which was originally about a new government coming into power, has taken on a new level of importance and could now be turned into an opportunity for the government to restore its damaged credibility.
But in the market, many people are very pessimistic about the outlook. More forecasts emerged after last week’s turmoil, with even former U.S. Treasury Secretary Lawrence Summers predicting that the pound will fall below parity with the dollar. Bloomberg’s options pricing model puts the odds of sterling falling to 1 against the dollar in the next six months at one in four, up from 14% on September 22.
Others are more worried about future UK debt. It is troubling that central bank support through quantitative easing, the saviour of gilts, is now backfired as officials try to rein in an out-of-control price surge.
“The British government bond market is gradually adjusting to the dramatic changes in the fiscal situation and the huge supply and demand outlook.” Analysts at HSBC wrote in a report on September 23. “The return of massive borrowing comes at a time when the BoE has also turned from a bond buyer to a seller and, more importantly, other investors are increasingly concerned about the credibility of the UK’s finances.”
Sterling fell after Kwarten’s speech on September 23, the 10-year bond yield rose more than 30 basis points to 3.83%, and the five-year bond rate rose by a record 51 basis points.
Meanwhile, traders expect a further 120 basis points of rate hikes at the Bank of England meeting on Nov. 3, more than double the rate hike to 2.25% on Sept. 22. Traders are also considering the possibility of a rate hike during the meeting, said Trevor Pugh, head of Treasury brokerage and agency at interdealer brokerage Tradition Ltd.
The new chancellor of the exchequer denied investor panic after the pound slumped, telling the Financial Times that “markets are always volatile – it’s important to stay calm and focus on long-term strategy.”
Right now, the market’s view on the long-term strategy doesn’t appear to be clear.
“Unless there are tangible measures to address fiscal issues, or the economy shows surprisingly strong growth figures, investors will likely continue to avoid the pound.” ING’s Antoine Bouvet and Chris Turner wrote on September 23. “We think the dollar rally is also in overdrive, so the market may be underestimating the odds of a parity between the pound and the dollar.” (Fortune China)
Translator: Xia Lin
The market selloff that followed the release of the UK government’s fiscal plan extended into a new week, heaping the pressure on Liz Truss’s days-old administration.
Kwasi Kwarteng’s all-out gamble on tax cuts and extra borrowing to stimulate the economy sparked a ferocious and damaging assessment from investors on September 23 that sent UK assets tumbling. Seemingly unperturbed by the response, the Chancellor this weekend pledged even more tax cuts.
When markets reopened in Asia on September 26, the slump showed few signs of abating, as the beleaguered pound dropped to a fresh 37-year low against the dollar. If the rout continues to deepen as traders continue to deliver their real-time verdict this week, the selloff risks moving beyond a short-term embarrassment for the government into a more profound crisis that could necessitate a rapid policy response.
With the pound sliding as much as 0.9% to below $1.08 on September 25 night, the opening of the gilt market at 8 a.m. on September 26 will also be one to watch.
“With broad unfunded spending on the fiscal side unmatched by monetary policy to offset the inflationary impulse, the currency is likely to weaken further,” Goldman Sachs analysts including Kamakshya Trivedi wrote in a note to clients on September 23.
In a sign of the historic severity of September 23’s selloff, the pound at one stage was set for its worse day against the dollar since the record crash that followed the Brexit vote in 2016. In the end, the 3.6% slump was the seventh-worst in the past 50 years. At the same time, government bond yields soared, by a record amount on some maturities, as investors punished the Chancellor for his unapologetic dash for growth.
If maintained, the move in yields will dramatically inflate the cost of the extra £400 billion ($434 billion) of borrowing the Resolution Foundation estimate is needed over the next five years to fund the plan, adding to an interest bill already bulging thanks to sky-high inflation and Bank of England rate increases.
The market moves this week could have huge implications. The Telegraph reported on September 24 that Truss will face a rebellion from Tory backbenchers against her tax cuts if the pound falls to parity with the dollar. Meanwhile, some in the markets are already calling for emergency BOE action to stem the tide, an unprecedented action in modern times that would risk adding to the sense of panic.
Former BOE official Adam Posen said on Twitter that he expects Andrew Bailey to “say publicly by mid-week that if GBP down, rates up.” He also mentioned the possibility of Treasury intervention to prop up the pound on September 25 before the open, but others pointed out that Britain’s foreign currency reserves are a fraction of those of the likes of Japan, which pursued the same policy last week.
If the weekend break has brought some calm, and moves start to retrace on September 26, that will buy Truss and Kwarteng time to try to seize back the agenda. That would increase the importance of the Tory Party Conference early next month, which now risks turning from a coronation of the new government into a chance to restore already-battered credibility.
But the outlook from many in the market is far from rosy. The turmoil last week led to more predictions, including from former US Treasury Secretary Lawrence Summers, that the pound will decline below parity with the dollar. Bloomberg’s options pricing model now shows a one-in-four chance the pound will reach $1 in the next six months, up from 14% on September 22.
Others are expressing concerns over the future of UK debt. Worryingly, the central bank support through quantitative easing, previously a savior of gilts, has now been thrown into reverse by officials looking to keep a lid of runaway price gains.
“The gilt market is adjusting to a seismic shift in the fiscal landscape and a mammoth supply-demand outlook,” HSBC analysts wrote in a note on September 23. “The return of such large-scale borrowing of this nature comes at the same time as the BOE is also turning from a buyer to a seller of bonds, and — more importantly — other investors are increasingly concerned about the UK’s fiscal credibility.”
After Kwarteng’s speech on September 23, the pound slumped, yields on 10-year debt rose more than 30 basis points to 3.83%, and the rate of five-year notes jumped by a record 51 basis points.
Meanwhile traders fully priced 120 basis points of additional rate hikes from the BOE by its Nov. 3 meeting — more than double the size of the move announced on September 23 that took rates to 2.25%. Traders are also now pricing in the possibility of an intra-meeting hike, according to Trevor Pugh, head of gilt inter-dealer broker and agency desks at Tradition Ltd.
Following the event, the new Chancellor denied investors were panicking, telling the Financial Times that “markets move all the time — it’s very important to keep calm and focus on the longer-term strategy.”
For now, the market’s view of that strategy appears dim.
“Unless something can be done to address these fiscal concerns, or the economy shows some surprisingly strong growth data, it looks like investors will continue to shun sterling,” ING’s Antoine Bouvet and Chris Turner wrote on September 23. “Given our bias for the dollar rally going into over-drive as well, we think the market may be underpricing the chances of parity.”