Truss implosion shows big change in financial climate
The astonishing political demise of British Prime Minister Liz Truss shows what can happen when ambitious plans collide with a new financial market reality that places the fight against inflation above all else.
Truss resigned Thursday after just 44 days in office, a casualty of the market turmoil triggered by her plans to increase government borrowing and cut taxes despite an annual inflation rate above 10 percent.
The Truss implosion was fueled by distinctly British considerations. But the market upheaval — which at one point saw investors judge Britain a worse credit risk than notoriously profligate
Italy — \ ignited unexpected difficulties in British pension funds and started a search for the next financial domino that could topple as interest rates climb.
Bond mutual funds, pensions, corporate debt and government finances all are being scrutinized for hidden weak spots, analysts said, as the Federal Reserve continues raising interest rates at the fastest pace in 40 years. Investors expect the central bank to lift rates several times in the coming months in a bid to cool off rising consumer prices, including at its next meeting in November.
“The Fed will just keep hiking until something breaks,” said Eric Robertsen, global head of research and chief strategist for Standard Chartered Bank in Dubai. “I think it’s more likely that there will be a financial market crack before there’s an economic crack.”
After years of easy money policies, the Fed is leading central banks in tightening credit to battle painfully high inflation. Interest rates have moved sharply higher in the United States, United Kingdom, Europe, Canada and dozens of smaller countries in the broadest such campaign to hit the global economy in a quartercentury.
Bond market volatility this month hit its highest level since early March 2020, when the Fed was forced to step in to buy $1 trillion in U.S. treasury securities. Sluggish trading in treasuries — normally the most liquid market on earth — now has Treasury Secretary Janet L. Yellen considering buying back some government securities from traders to ease market functioning.
The markets’ grinding gears do not mean an imminent financial crisis, analysts said. But the friction illustrates the bumpy transition that the global economy is making from more than a decade of ultralow interest rates to an era of more costly credit. With the Fed promising months of additional interest rate hikes, more market volatility is likely.
Globally, stocks have lost roughly $30 trillion in value so far this year while bonds have suffered one of their worst years ever.
The financial reset is occurring as international risks are multiplying, with the war in Ukraine and the souring of U.S.-China relations roiling markets.
Unpredictable linkages between finance and geopolitics have flared in earlier eras, such as in 1998 when the hedge fund Long-Term Capital Management collapsed during the Russian financial crisis, requiring a U.S. government-led bailout.
“There is a risk of a disorderly tightening of financial conditions that may be amplified by vulnerabilities built over the years,” the International Monetary Fund warned this month in a report, which said financial stability risks had grown since April and are “significantly skewed to the downside.”
For more than a decade, while interest rates were low and the Fed actively purchased government and mortgage securities, it was easy for investors to sell most assets.
Now as the Fed and other central banks tighten monetary policy, normally liquid markets are becoming more congested. Investors who want to unload, say, a Treasury bond, encounter delays or wide gaps between their asking price and what buyers will pay.
Since securities backed by the U.S. government are regarded as risk-free, their price is the key to determining the value of other financial assets. So problems buying and selling treasuries can infect other markets.
“Liquidity has been papering over weaknesses in other markets, and now we’ll see what they are. And we’ll see it in a bunch of assets,” said Megan Greene, chief global economist for the Kroll Institute.
In the United Kingdom, while Truss took a beating for delivering a risky economic plan that had not been vetted by independent analysts, British pension funds became the center of the crisis.