Client Update - 14th October 2022

Markets are jumping on any good news and as Kwasi Kwarteng flies back early from the US where he was attending the International Monetary Fund (IMF) annual conference, the suggestion is that he may be about to pull back on some of his fiscal reform and markets have started a welcome recovery, along with the pound rallying in value. Liz Truss is due to speak later today.

According to the FT, when Kwasi Kwarteng told the media in Washington this week that he was “not going anywhere”, Conservative MP’s questioned whether he meant he was staying in his job, or he was remaining overseas for good. The future for our current chancellor looks bleak. Yesterday we had US inflation data that fell to 8.2%, below the previous months reading of 8.3% - initially leading to a market sell off as it was higher than expected. This then changed dramatically as the market then decided it was actually good news, showing that inflation had peaked, and US equities rebounded by some 5%, although some of this may have been institutional investors covering their short (negative) positions. Whatever the reason, we welcome the positive market reaction.

The Bank of England support package for the gilt market, despite some confusion, is due to end today. On Monday they issued a statement saying they were “prepared to deploy unused capacity to increase the maximum size of the remaining auctions” and on Tuesday broadened out the qualifying assets to include index-linked gilts, which saw huge volatility at the start of the week. Bank Governor Andrew Bailey poured fuel on the fire with his aggressive comments delivered at an IMF forum on Tuesday, when he said bluntly “my message to the funds involved and all of the firms is you’ve got three days now…you’ve got to get this done”. The Financial Times reported that the Bank had privately communicated to market participants that the emergency program would be extended if market conditions required it, but this was denied by a Bank spokesperson.

The UK government remains keen to distance the mini-budget from causing the volatility in UK gilts even though it’s pretty obvious from the charts that the unfunded tax cuts were the cause of the bond selloff, which in turn has caused significant difficulties for pension funds and maybe the pressure to replace the chancellor has now got too great. Irrespective, we now know for sure that the government will introduce the medium-term fiscal plan, along with the Office for Budget Responsibility report, on 31 October. I now expect that we will see some policy change before then in terms of reversing more of the tax cuts given the expected funding gap that the OBR could forecast if the government’s tax plans remain in their current state. Market expectations of such a U-turn appear to be behind yesterday and this morning’s rally in gilts. Whether this rally can be sustained depends on fundamental and technical reasons. In the absence of Bank of England support, next week could still be ‘interesting’. Do have a good weekend.