Ten days that shook the world
Historians amongst you might remember a famous book ‘Ten Days That Shook the World’. Written by John Reed, an American journalist and socialist, it presented a first-hand account of the 1917 Russian October Revolution. We are living through history, including some revolutionary decisions.
Looking at the past week, Friday 23rd saw the Chancellor announce his radical tax and borrowing plans. Monday saw sterling fall to new lows versus the dollar and euro, leading to a statement from the Bank of England intended to reassure financial markets. Tuesday witnessed an unprecedented statement from the IMF criticising aspects of the UK government’s announcement: “given elevated inflation pressures… we do not recommend large and untargeted fiscal packages”. There was also a statement from Moody’s Investors Service that the UK’s credit rating could be affected as “Large unfunded tax cuts are credit negative”. Wednesday saw the Bank of England tear up its plans to begin selling government bonds and instead introduce a ‘temporary’ plan to buy gilts in order dampen disorderly market conditions. Thursday saw the FTSE100 stock market index at a one year low, partly due to worsening European inflation data. This Monday saw a U turn on the plan to cut the 45p tax band.
All grist for the press to chew over. The most important event, by far, was the Financial Policy Committee of the Bank announcing that it would buy up to £65 billion of gilts to prevent a surge in yields. Its guidance in the summer had been that would reduce the size of its bond holdings by £80 billion to £758 billion over the next 12 months. Instead, it came to the rescue of a gilts market in turmoil. As the financial press has reported, there were complicated issues facing pension schemes and the technicalities of liability driven investing which potentially meant massive losses for some pension schemes. In addition, the Bank will not have ignored the fact that rapidly rising gilt yields worsen the debt servicing burden facing the government, whilst the Bank will be wary of a second cost of living crisis threatening households. If mortgage rates go up to 6%, the average household refinancing a two-year deal would see monthly repayments jump from £860 to £1,490.
It is important to recognise how large and rapid the moves in gilt yields have been. Tuesday saw the biggest move up in inflation adjusted gilt yields on record, and Wednesday saw the biggest move down. More generally, the 5 day move in gilt yields is the worst since at least 1989. For the technically orientated, the changes in gilt prices on a 12-month basis are all 3 to 4 standard deviation moves, which is ‘tail-event’ territory.
There will be much criticism of the UK government in coming days and weeks. The Bank of England may have bought some time, ahead of any statement by the Chancellor and the Office for Budget Responsibility’s official forecasts scheduled for 23rd November. However, the Bank of England’s volte face is actually a prime example of a deeper seated issue facing many countries – the divergence between an ever tightening monetary policy and an ever easier fiscal. For example, European capitals are debating how much support to give their economies as energy prices rise once again after the sabotage to the Nord Stream pipelines.
This was a week, however, when European bond yields would rise whatever happened across the Channel. The ECB’s speech machine continued apace. Croatia’s Boris Vujcic lauded this month’s 75-basis-point hike as “the right way to go.” The ECB should opt for a “big” increase in rates in October, said Martins Kazaks, while Gediminas Simkus and Madis Muller also indicated they’d back significant moves. All this came alongside news that the headline German inflation rate has reached 10.9% from a year earlier. Unsurprisingly, markets expect the ECB to move by 0.75% in November. December’s decision will depend on two factors, how high gas prices go in coming weeks and the ECB’s forecasts for the coming year.
The US yield curve continues to invert. Markets are pricing in another move of 0.75% at the November meeting and then a further 0.75% in the following two meetings, with the peak in rates seen about 4.75%. Fed member Loretta Mester spoke for many when she noted that “wishful thinking cannot be a substitute for compelling evidence. So before I conclude that inflation has peaked, I will need to see several months of declines in the month-over-month readings,” Chicago Fed chief Charles Evans concurred when he said the FOMC’s current target range is “not nearly restrictive enough” while markets are not volatile enough to knock the Fed off its current tightening course.
After 10 days of surprises, where next for the revolution in monetary and fiscal policy…..
Bond yields at the time of writing
% 2 year 5 year 10 year
USA 4.20 4.04 3.80
UK 4.29 4.41 4.09
Germany 1.78 1.98 2.12
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making