A costly exercise in self harm
Central bank intervention is now rife in markets, with the Bank of Japan propping up its currency and, more recently, the Bank of England intervening in the Gilt market. Such developments are symptomatic of ongoing market stresses, resulting in weak equity and bond markets this year.
From a currency translation viewpoint, US Dollar strength continues to benefit UK investors with allocations in US and Asian equities. A divide in performance between the two sides of the Atlantic (i.e. US vs. Europe) has been evident in equity and currency markets of late and looks set to continue as a hard winter of gas concerns awaits Europe.
Closer to home, we have seen a baptism of fire for Liz Truss and Kwasi Kwarteng, (the new Chancellor of the Exchequer) – mostly self-inflicted on their part. While some tax cuts were expected by the new Conservative government, the extent of them spooked markets, with Sterling having traded as low as $1.035 against the Dollar. This is in stark contrast to a rate of $1.21 at the end of June and demonstrates a vote of no confidence in the UK by overseas investors.
We were surprised to hear during the earliest days of the new government, that Kwasi Kwarteng sacked the Permanent Secretary to the Treasury. Kwarteng then effectively ignored the Office for Budget Responsibility to avoid scrutiny as to how the extra borrowing required to offset the huge tax cuts and funding energy subsidies proposed by his Budget, would be secured.
This dash for growth in highly unpromising market conditions has created a crisis of political and economic confidence. With Government finances already stretched in capping soaring energy bills (which, politically, could not be ignored), this significant further borrowing tipped markets into panic mode.
Truss and Kwarteng insist their strategy justification will be clarified in November, when the next formal budget is scheduled. However, the International Monetary Fund (which is ultimately responsible for helping to bail out failing nations through emergency lending) is pushing for them to act sooner. While we have had a partial easing with the Chancellor reversing the 45% tax rate cut, in aggregate this only contributes £2bn-3bn of the package. So, while a welcome reversal, this will be unlikely to alleviate investor concerns around funding of the growth package.
Meanwhile, last week the Bank of England had to intervene in the government bond market, as loss of confidence in Kwarteng and Truss had seen yields on Gilts jump significantly (the UK 10-year yield topping 4.5%). A formal bond buying programme has commenced, the antithesis of what was originally planned to help to reduce the impact of ongoing pressure on the Gilt market. This has wider ramifications in terms of mortgage affordability and stability in the UK financial system, so it looks likely further measures will have to be taken to reduce the impact of this current uncertainty.
Markets have not taken the matter in their stride and the last few days of September were generally punishing for even conservative investors, who have seen price declines in defensive areas of the market, including income orientated funds. This is because the relative attraction of the income yields on these investments is no longer at such a premium to “risk free” Gilts.
We continue to monitor the wider investment universe closely and have positioned portfolios with holdings which do offset some of the current uncertainty in UK markets. While the Bank of England bond purchasing programme, and reversal of the 45% tax cut, has helped steady the 10-year yield around 4.0% and the Sterling rate at $1.12, our positioning remains defensive. That said, we have been encouraged to note the performance of other overseas assets and absolute return hedge funds proving their worth recently. We are still focussed on the initial early signs of a reduction in the rate of US and UK inflation and have raised substantial cash balances to take advantage of this change in trend.
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