Government bonds sold off sharply this week, led by UK gilts, following the UK Chancellor of the Exchequer’s mini budget last Friday when he announced up to £45 billion worth of unfunded tax cuts. On Monday, the pound fell to a record low versus the dollar of $1.035, followed by sharp upward moves in gilt yields, which move inversely to price, as the 10-year yield hit 4.59%, with 30-year yields touching a 20-year high in excess of 5%. This forced up government debt yields around the world, as 10-year US Treasury yields went above 4%. The selloff in UK gilts was eventually put down to forced selling by pension fund liability driven investment strategies, or LDI, having to meet derivative margin calls as gilts sold off sharply. It was not until the Bank of England intervened, promising to buy up to £65 billion of gilts, that some sort of normal order resumed, with government bonds staging a rally as yields came back down. The sharp increase in debt costs only served to increase recession worries, dragging equity markets down in tandem.
As of 12pm on Friday, London time, US equities fell 1.4% over the week, whilst European stocks dropped 1.2%. The UK market fell 2.5%, although by far the most pain was felt in mid cap stocks which lost 5.7% of their value. Japanese stocks fell 4.2%, whilst Australian equities dropped by 1.5%. The emerging markets sold off by 3.6%.
Bond markets had settled down by the end of the week, following the Bank of England’s intervention, with 10-year US Treasuries currently yielding 3.71%, German bunds 2.09% and UK gilts 4.05%. The Bank of England, which was about to start selling down its gilt holdings as part of its efforts to get inflation under control, has committed to buying £5 billion of gilts a day up to the 14th October, thereby providing liquidity to LDI pension fund schemes.
The pound has also rallied from its record low versus the dollar, now trading just under $1.11 and just over €1.13. Where UK asset prices go from here in the immediate term will be largely dictated by government policy. So far, the Prime Minister, Liz Truss, and her chancellor, have committed to ploughing on with their fiscal easing whilst introducing supply side economic reforms to boost growth. However, they have also agreed to work with the Office for Budget Responsibility to try to persuade financial markets and the public that their plans stack up. The biggest push back so far, has been the idea that the government is trying to boost growth, whilst the Bank of England is trying to reign in demand to squash inflation, somewhat diametrically opposed policies.
Amidst the turmoil, gold rallied by the end of the week, rising 1.2%, now trading at $1,675 an ounce. Similarly, so did crude oil, up by 2.8% for the week, priced at $88.6 a barrel. Whilst European natural gas, having spiked by close to 18% on news that the Nord Stream 1 and 2 gas pipelines had been ruptured after a series of explosions, finished the week down by over 6%, trading at $169 a megawatt hour. Although no one has taken responsibility for the damage, all fingers are pointing at Russia whilst experts have said only a state actor could have carried out such large explosions.
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