AS WE wait to see how the markets react to our latest Chancellor’s pronouncements, let’s just consider what has happened.
The context, which you would never know from mainstream media front page coverage, is that bond yields, and thus interest rates, have been rising across the industrialised world, as the charts below from Trading Economics show. The US, European and UK bond markets are pretty much in step – unsurprising in a global economy. Investors want higher returns for the increased risk of lending to governments.
This is a hugeproblem for this government and for any Chancellor it appoints, as the UK has run a deficit for over 20 years. Unless and until it can generate a surplus it will need to borrow new money, as well as more to replace the historic borrowings as they come due.
There are only three ways out of this bind: spend less, tax more or grow the economy. The former, as Ewen Stewart explained in TCW on Saturday, has eluded almost all governments in my lifetime and most dramatically since 2008. Taxing more is the Sunak and Corbyn solution – it comes with the risk of stifling growth. It has. So Truss and Kwarteng went for a growth stimulating mini-Budget. Again, as Stewart set out, while they needed to mark a change of policy quickly, withno spending cuts announced it signalled more borrowing. Investors crunched the numbers and decided that they would like fewer UK gilts in their portfolio, so started selling.Lots of sellers pushed the price down.
In parallel there was an impact on the pound spot price. At least some of those who sold gilts, for which they received sterling, wanted to buy US Treasury Bills, so they needed to sell the sterling to get dollars. That triggered the fall in the value of the pound, again due to the surfeit of sellers.
Then two unforeseen things happened. The first, which was a genuine surprise, was that the IMF issued a statement criticising the end of the 45 per cent tax rate. (Quite why an organisation that exists to secure global financial stability chose to comment on a cut worth about £25 billion – a rounding error – remains unclear. Conspiracy theorist will no doubt be having fun.) That may or may not have spooked the markets; it certainly spooked the political commentariat.
The second thing, which should not have been a surprise, was that many pension funds faced margin calls as a result of their Liability Driven Investment (LDI) schemes. These are complex (a 16-page explanation is here) but if the market moves unexpectedly users of the scheme (pension funds) need to deposit collateral with the provider, usually in the form of gilts or cash. With falling gilt values the need was cash, so a lot of pension funds had to sell gilts (and other assets) to raise cash. This death spiral was stopped by the Bank of England stepping in to buy gilts from pension funds.
(Note that these LDI schemes were supposed to have been stress-tested against just such a scenario. Once again the City – and Wall Street – made fees from selling a product that didn’t work as planned. That’s an inexcusable failure of financial regulation.)
That was the sequence of financial events. The politics is more opaque. Clearly it’s bad news if the markets don’t like a policy, or the policy leads to a short-term slump. Reassuring any market in a time of turmoil requires a clearly enunciated credible strategy, persuasive presentation and a unified voice. As has been extensively commented on, Kwarteng failed on the first, Truss on the second and the death knell was the decision of the self-interested, overambitious and failed elements of the Parliamentary Conservative Party to start brandishing knives, and plotting and briefing against their own leadership.
So we now have Jeremy Hunt as a Chancellor, raising taxes. Quite how this will stimulate the growth that this country desperately needs (and the policy reason Truss was preferred over Sunak, especially by the grassroots) escapes me as it must any dispassionate observer. Worse, the usual suspects are blaming it on Brexit (which is wrong and a red herring as charts above make clear) while Whitehall is busy explaining why cuts to government spending are impossible (with their Labour mouthpieces in the Commons supporting them).
Writing on a Sunday, it’s too early to tell if this is the Tories’ latest political strategy. A ruling party eviscerating itself is far from reassuring.
If the market thinks that the current level of debt is about as much as it can digest (the implication of rising yields) the million dollar question is how on earth is the UK going to find the further £2trillion to £3trillion that Net Zero will cost on top of exponentially rising monthly debt repayments.
We could be on the road to an IMF bailout and control of the British economy.