Weekly podcast – Market overview
This week’s host, Investment Manager Andrew Cartwright, discusses the ups and downs of the past week with Head of Fixed Interest Research, Richard Carter and Investment Adviser, Harry Gibbon. Among the topics discussed – mini-budgets, currencies under pressure and the upcoming COP 27 summit.
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Market overview – Alan McIntosh, Chief Investment Strategist
The pound fell to a record low against the US dollar and UK government bond yields moved sharply higher after Kwasi Kwarteng, the new chancellor, announced the UK’s largest set of tax cuts in half a century in a mini budget last Friday. The raft of measures, aimed at stimulating the UK’s flagging economy, included the abolition of the 45% income tax bracket, the lowering of the basic rate income tax bracket to 19% and maintaining the corporate tax rate at 19%, thereby cancelling the planned increase to 25%, in a package that is estimated to cost the Treasury £45bn.
These moves come just a matter of weeks after a largescale package to alleviate the energy crisis - worth an estimated £150bn - was announced and will require the Treasury to borrow an additional £72bn, via the Debt Management Office, in the current financial year. Taken together these acts represent a major fiscal stimulus, designed to kickstart a stuttering economy. The latest forecasts from the Bank of England (BoE) - published the day before the mini-budget was announced - predict UK GDP will fall by 0.1% in the third quarter of the year, representing a significant deterioration since August’s forecast of 0.4% growth, and which would, if they transpire, mark a second consecutive quarterly decline, signalling a technical recession.
The extra supply of UK government bonds at a time when the BoE is looking to reduce the stock of assets accumulated from quantitative easing programmes - it is aiming for £80bn of gilt sales in the next 12 months, bringing its total assets down to £758bn – has pushed borrowing costs sharply higher.
The market reaction to the news was sizable with the yield on a two-year gilt jumping to around 4.4%, up from just 0.4% a year ago, while Friday’s daily gain for the five-year gilt was the largest since at least 1990. In currency markets sterling fell below US$1.04 early on Monday morning to hit its lowest level since the present system of floating currencies began in 1971, following the collapse of the Bretton Woods system. UK stock markets also experienced some selling, although the depreciation in sterling softened the blow to some extent for large-cap benchmarks.
There are some mitigating factors that alter the context to some extent for these moves, such as the GBP/USD depreciation is largely a result of a surging US dollar and global equities have been back under pressure in recent weeks as global bond yields have resumed their march higher, but it is becoming increasingly clear that some investors are beginning to treat UK assets with a sense of trepidation.
The BoE delivered yet another interest rate increase last week, taking the base rate to a 14-year high of 2.25% after announcing the central bank’s seventh successive hike following a rate decision and its second 50 basis points increase in a row. Markets are not expecting this hiking cycle to end anytime soon as the BoE continues to aggressively tighten monetary policy in the pursuit of curbing the highest level of inflation in a generation – the last consumer price index (CPI) fell by 20 basis points but remains elevated at 9.9% year-on-year – and are pricing in further increases in the coming months with the terminal rate now seen in the region of 5.50%. There is also growing a number of rumours doing the rounds of an emergency meeting in the coming days, in response to the mini-budget.
75bp hat-trick for Fed
In the US, last week the Federal Reserve (Fed) announced a third consecutive 75 basis point increase to leave its base rate at 3.00%-3.25%. The move was widely anticipated with markets even pricing in a non-negligible chance of a 100 basis point move after the latest CPI print came in higher than expected. The US dollar extended its gains following the large increase, moving up to its highest level in over 20 years. The strength of the greenback accounts for a significant proportion of the decline in sterling year-to-date, with the US dollar index up around 18% in 2022 and the GBP/USD rate down in the region of 21%. Another way of looking at this is that sterling is down by around 8% versus the euro.
The decline in the GBP/USD rate has cushioned UK investors in US stocks, with US large cap benchmarks off by around 22% year-to-date, a remarkably similar level to the depreciation in the GBP/USD exchange rate. Last week, US large caps fell by around 4.6%, slightly less than the MSCI All Country World Index which was down by 5.0%. UK large cap indices were lower by around 3.0% as the weakening currency softened the decline and European equivalents were off in the region of 4.3%.