September was an exceptionally volatile month, particularly for UK investors. In the month we saw the pound dollar exchange rate hitting its lowest ever level, of $1.03, and daily Gilt price moves in the 10s of percent. An already weak currency and government bond market in the UK was aggravated by the mini budget delivered by the new government on Friday 23rd September.
What was clearly intended to be an upbeat and aspirational announcement was taken by markets as a reckless loosening of fiscal discipline at a time of rising borrowing costs and high inflation. Initial movements triggered liquidity issues in the pensions industry, causing the value of some bonds to fall dramatically, and yields to shoot higher. Such was the stress in the market, that the Bank of England’s Financial Policy Committee intervened with an unlimited but time constrained bond buying program, targeting long dated bonds, where the issues were most acute. Bonds rallied and yields fell as a result.
In the short term, the Bank of England is clearly willing to underwrite the Gilt market, ensuring that market moves are orderly. However, it will take an exceptional interest rate rise by the Monetary Policy Committee in November, potentially up to 2%, as well as a more fleshed out fiscal plan by the chancellor, to stabilise markets. Many of the proposed reforms, as well as the tax cuts, will take time to make any impact on the economy, meaning that management of the market expectations in the interim will be important. Government bond yields now trade with yields in excess of 4%, having breached 5% at points over the month. The highest level since 2008.
While the timing and the management of the announcement was ill judged, the change in direction by the government may be positive for the domestic equity market. The reversal of the National Insurance and Corporation Tax increases will enhance company profitability, all else being equal. While international sentiment towards the UK is deeply negative, and domestic confidence is at record lows, any improvement in these could cause a re-rating in assets that have seen persistent headwinds since the Brexit referendum. It is also clear that UK listed shares, regardless of where they derive revenue or how it is produced, have experienced share price falls. Investment trust discounts on the UK market have widened, again, in instances where the underlying assets are not linked to the health of the UK economy. All these point to short term, distressed selling which can only last so long.
Although there has been a particular focus on the UK over the month, global economic indicators continue to deteriorate, pointing to a recession in many key economies. Bringing down short term inflation continues to be the focus of central bankers and markets, however, with many inflationary pressures already beginning to ease and a recession increasingly likely, it may not be long before rate cuts begin to be considered and priced into markets. This may have considerable implications for bond yields and equity markets.