UK bond traders issue stern warning to next PM
Traders in UK government bonds helped topple Liz Truss. Now they’re setting their sights on their next goal: ensuring her successor will stick to the fiscal discipline required to shore up the country’s fragile finances.
If word gets out the Conservative Party is considering a new prime minister who embraces fiscal largesse or any other unorthodox position, the market reaction, they warn, will be as swift and severe as the wild four-week rout that followed Truss’s illfated proposal to slash taxes and boost spending.
As Gordon Shannon, a portfolio manager at TwentyFour Asset Management, put it: “Don’t mess with bond vigilantes.”
Some of this, of course, is just trading floor bravado. Traders and investors are feeling powerful after watching Truss step down after only 44 days in office. But some of that power is real.
They now have the ability to influence policy and politics in the most meaningful way in years. The Bank of England (BOE) is slowly stepping out of the market as part of its push to tame inflation, ceding more ground to investors to bid yields higher or lower in response to policy choices.
“The markets are clearly in charge now,” said Scott Service, portfolio manager and co-head of global fixed income at Loomis Sayles.
Truss’s premiership saw gilt yields post some of their biggest moves on record and the pound sink to an all-time low after the announcement of the largest package of unfunded tax cuts in half a century.
A new leader will be in place ahead of the slated announcement of the government’s medium-term fiscal plan that was due on October 31, said Graham Brady, a senior Conservative lawmaker.
“Clearly a vote winner right now is: ‘I’m going to be a really steady hand on the rudder and try and rebuild a bit of credibility,’” said Lyn Graham-Taylor, a rates strategist at Rabobank. The government appears to have learnt its lesson, abandoning pledges for vast unfunded tax cuts. Veering away from the path set out by current chancellor of the exchequer Jeremy Hunt could easily plunge markets back into turmoil.
Meanwhile, traders have been reducing their bets on more aggressive BOE tightening since the government began rolling back its more expansive stimulus.
“That trend could continue if the government opts for an even more restrictive fiscal policy.
“If the UK decides to go for austerity that would be very hard for the Bank of England to prescribe very high rate hikes in the coming months, with the risk of damping growth,” said Morgane Delledonne, head of investment strategy for Europe at Global X ETFs.
The BOE meets to set rates on November 3 and the market is currently pricing a high probability of at least a 75 basis-point increase. There’s no denying that whoever takes office has their work cut out for them. Inflation in the UK is running in the double digits, the economy is sliding towards recession and the prospect of a debt deluge looms large.
“No new leader will want to fall foul of the markets in the same way as the outgoing prime minister,” said ING strategists including Antoine Bouvet.
The markets are clearly in charge now
Scott Service
Portfolio manager and co-head of global fixed income at Loomis Sayles
After Liz Truss’s resignation, companies from Aldi to Ryanair took to social media to poke fun at the UK’s shortest-serving prime minister, and the chaos that defined her time in office.
The low-cost carrier issued her a mock boarding pass to “anywhere”, while the discount grocer, on Twitter, made a comic reference to the Daily Star asking whether Truss would outlast a head of lettuce. She didn’t.
However, beyond the levity, business is facing up to the reality that Truss’s departure after only 44 days in office complicates an already tricky environment.
High inflation, rising borrowing costs and persistent labour shortages have driven confidence among small businesses to lows only previously seen during Covid lockdowns.
UKHospitality, the Federation of Small Businesses and other groups representing companies are calling for a swift return to stability and continuity in policymaking.
“The politics of recent weeks have undermined the confidence of people, businesses, markets and global investors in Britain,” said Tony Danker, director-general at the Confederation of British Industries.
“That must now come to an end if we are to avoid yet more harm to households and firms.”
Brian Duffy, the CEO of Watches of Switzerland, the biggest dealer in Rolex watches in the UK, said he’s “desperate for stability and direction”.
At the top of the list of concerns for business is the energy support package, a policy backed by Truss. The programme, set to run through April,
Political chaos has created a bewildering environment for companies weighing investment
was seen as a lifeline over the winter for firms ranging from fertiliser plants to hotels and launderettes.
Yet even before Truss stepped down, companies were calling for more clarity over what would happen when the aid package ends. Now some are asking if it will go into effect at all if the premiership change brings a new chancellor with new economic priorities.
“This is a huge concern for businesses like ours,” said Andrew Jenkins, whose Orchard Lodge B&B in Scarborough, England, is seeing electricity bills double from last year. “It could finish a very significant number of businesses off.”
Energy costs are an especially pressing issue for agribusinesses, and not just in winter. Drying grain, for example, requires energy in warmer months, while fertiliser makers and feed mill operators use energy throughout the year.
The Agriculture Industries Confederation sent a letter this week to the department for business, energy & industrial strategy demanding further clarifications.
“Business certainty and planning is at a critical point in our nation’s food security,” the trade group’s CEO, Robert Sheasby, wrote to business minister Jacob Rees-Mogg.
With Truss gone and another government shake-up imminent, getting answers to those questions may take time.
Across industries, the prolonged period of upheaval that began with the ousting of former prime minister Boris Johnson earlier in the year and reached a market-roiling apogee under Truss has created a bewildering environment for companies weighing investment in their businesses or the UK at large.
“Let’s hope the process of choosing the next leader is done efficiently and we’ll have a more stable situation going forward,” said Duffy at Watches of Switzerland.
“Some permanent damage has probably been done, or at least it will take some time to undo it.” —