UK political turmoil causes another volatile week in markets. This week we look at how markets have fared following the u-turn on the 'mini budget'.
US inflation surprises to the upside
US inflation continues to surprise to the upside, rising 0.4% in September vs. consensus estimates of 0.2%. Figures showed that core CPI, which strips out energy prices, rose by 0.6%, with core services inflation accelerating. This is of particular concern as these price rises tend to be stickier.
Rental increases are starting to feed through to the numbers. Whilst more frequent data shows that rental price increases are starting to slow, the lagging nature of the CPI data means that this is still expected to remain high for some time yet, placing pressure on households and businesses.
The Federal Open Market Committee (FOMC), which sets US interest rates, has released the minutes from their September meeting, in which they emphasise that the cost of ‘taking too little action to bring down inflation’ outweighs that of taking too much. Further comments highlighting the historical lessons of easing rates prematurely have stoked expectations that US rates will stay higher for longer.
UK political turmoil causes another volatile week in markets
The UK saw another week of volatility in politics and markets as the prime minister, Liz Truss, was forced to u-turn on the majority of her budget, replace her chancellor of the exchequer and face calls to resign less than 40 days into her term. The ‘mini budget’ announced on 23 September had spooked markets with the announcement of higher than expected tax cuts and a larger than anticipated energy relief package, both of which required funding via increased debt and came without independent financial analysis from the Office of Budget Responsibility (OBR).
The subsequent fall in the pound was significant, as was the rise in borrowing costs for the government, forcing Ms Truss to backtrack on most of her commitments. There was a further risk to financial stability from the collapse of pension funds using leverage strategies, making them forced sellers of gilts at a time when gilt prices were plummeting.
The new chancellor, Jeremy Hunt, has rolled back on the vast majority of the budget and reduced the energy support package, which had been due to last for two years. It will instead end in April 2023, be subject to independent analysis and reviewed to see how measures could be better targeted. Most of the announced tax cuts have been scrapped, meaning corporation tax will now rise, leading some analysts to predict a deeper recession.
The initial announcements had been particularly disruptive in gilt markets, forcing the Bank of England (BoE) to announce a time-limited bond buying programme, in direct opposition to the quantitative tightening it was due to begin this year. The BoE is likely to postpone its planned bonds sales, which are intended to reduce the bank’s balance sheet and tame inflation by tightening UK monetary policy. There is now an expectation that the BoE will raise interest rate by 0.75% at its November meeting.
Whilst the announcements and appointment of a new chancellor may have reassured markets, the outlook for the UK economy is worsening. Double-digit inflation is now being forecast, suggesting further interest rates rises and a recession – which may already have begun.
Market review
It was a negative week across all equity markets with the exception of Europe, where the Euro Stoxx 50 index was flat. In the US, the tech-heavy NASDAQ ended the week down over 3%. Falls in China were particularly pronounced following US sanctions on Chinese companies that buy or build semiconductors, with the MSCI China ending the week down over 6%.
UK bond markets were volatile. Inflation-linked bond prices fell by over 9% on the expectation of significant rate hikes in the future. Oil was down by over 6% as measured by the internationally recognised benchmark, Brent Crude.
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