Dear, oh dear

When former Chancellor Kwasi Kwarteng stood up to deliver his mini-budget, little did he realise what mayhem he was about to unleash.

The Bank of England (BoE) had to launch emergency support to avert a self-reinforcing sell-off in the long-dated part of the gilt market as pension funds with LDI (Liability Driven Investment) were forced to sell assets to raise cash to fund margin calls.

It is difficult to quantify the impact of the LDI crisis, but one leading independent pension consultant has estimated that some of the pension funds using LDI have had to raise immediately £100bn-£150bn. Ultimately, only £19bn of the BoE £65bn emergency gilt support package which lasted until the 14^th October was used. Unfortunately, when there is an immediate cash crisis it requires the need to raise funds from wherever able, so besides long-dated gilts, some funds would have no doubt been forced to sell property assets, equities and corporate bonds.

Distressed sellers -whatever the market – can easily trigger a domino effect as seen in the gilt market before the BoE emergency support. Higher government bond yields pushed up borrowing costs. Amongst the unintended victims of the mini-budget/LDI pension mayhem is the commercial property sector. Property valuations and property funds have been hit by the prospect of sharply higher borrowing costs.

In a rapidly developing series of events, Kwarteng has gone and Jeremy Hunt is the new Chancellor. He has made an emergency statement this morning ahead of the full fiscal announcement on 31^st October and almost all the measures in the mini-budget have been reversed.

Fresh measures announced today, will raise around £32bn a year. Hunt has also confirmed that the energy price guarantee will no longer last for two years, and will instead last until April 2023.

Is this the biggest political U-turn in British economic history?

Unfortunately, the damage to business and consumer confidence has been done. Liz Truss is facing mounting unrest from Conservative MPs. The country cannot afford either a leadership contest or general election with another 6-8 weeks of uncertainty. It appears the PM is living on borrowed time.

King Charles muttered as he greeted Liz Truss at Buckingham Palace ‘Dear, oh dear.’ What more can you say?

What have we been watching?

US interest rates and further shock waves from the recent UK mini-budget continued to overshadow markets, with the Bank of England forced to step in yet again but this time following dysfunction in the index-linked gilt market. A further escalation in the war in Ukraine didn’t help either. In addition, semi-conductor chip manufacturers came under pressure as the US announced new regulations to restrict the sale of certain chips for use in super-computers and artificial intelligence to Chinese companies.

Just for good measure, the IMF decided to pile on the misery by trimming its global economic forecast for 2023 from 2.9% to 2.7% -the weakest growth profile since 2001. The IMF also warned of a 25% chance that this might drop to 2%. It estimates a third of the world economy faces two consecutive quarters of economic contraction in 2023. The knock-on effect from the war in Ukraine and slower growth in China being amongst the main reasons.

Putin carried out missile strikes on cities across Ukraine, in what appears to be the most widespread attack since the early weeks of the war. This follows the explosion on the Kerch bridge between Russia and the Crimea. Despite the missile attacks, Sir Jeremy Fleming head of GCHQ said ‘Ukraine is turning the tide against exhausted Russian forces. We know -and Russian commanders on the ground know -that their supplies and ammunitions are running out.’

Another torrid week for UK gilts and the Bank of England as yields continued to spike upwards with the 30-year gilt once again briefly touching 5%! This was despite the fact that the Bank of England (BoE) raised its auction limit to £10bn and extended the range of bonds it would buy. Kwasi Kwarteng also sought, unsuccessfully, to restore some degree of confidence by announcing that his fiscal plans will be brought forward from 23^rd November to 31^st October but was then sacked. Jeremy Hunt has been appointed as Chancellor and in an effort to provide some measure of stability, a statement on the fiscal plan has been pulled forward from 31^st October to this morning. This might also have been driven by the decision by the BoE to end its emergency support on Friday.

The new Chancellor has plenty of work to do to restore confidence. The scale of the challenge was highlighted by the Institute for Fiscal Studies which suggested some £60bn of savings will be required by 2026-27. Sterling dipped to under $1.12. The BoE is also due to announce the next hike in UK interest rates on 3^rd November and the risk is that it has to lift by more than the expected 0.75%. Meanwhile, the UK economy contracted in August as the post- pandemic recovery in consumer services began to fade.

In the US, the Federal Reserve (Fed) released the minutes of its most recent meeting. The key line from this was ‘many participants emphasised that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.’ Interest rate futures are still factoring in another 0.75% rate hike. US inflation dipped in September to 8.2% in August although this was higher than expected. In addition, the core rate, excluding food and energy ticked up to 6.6% -a 40-year high. Given this, the Fed is even more likely to stick with its ‘hawkish’ interest rate policy.

President Xi Jinping speaking at the 20^th Communist Party Congress signalled there would be no immediate loosening of his controversial zero-tolerance Covid-19 policy, despite public fatigue over lockdowns and travel restrictions. Not helpful for China’s economic growth outlook. Ominously, he warned Taiwan that the ‘wheels of history’ are turning towards Beijing taking control of the island democracy.

Brent oil slipped back below $93 on concern about the global economic growth outlook and US interest rates.

Finally, who was it that predicted the death of cash due to contactless payment? The Post Office handled £3.45bn in cash in August, the highest total since it began recording volumes five years ago. It expects this trend to continue due to rising living costs and tighter budgets. Some people are finding it easier to monitor spending by using physical cash during the cost-of-living crisis.

Read Last Week’s Alpha Bites – Keep the home fires burning

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