RSMR Update: Recent Market Movements

Although not restricted to the UK, the recent turmoil in financial markets has been more concerning for UK investors than those in other regions. Prime Minister Harold Wilson’s quip that ’a week is a long time in politics‘, made during one of the many political crises in the 1960s, seems remarkably apt following this week’s mini budget from Kwasi Kwarteng.

The fallout from the tax cutting statement has yet to be fully digested, however the market reaction has been savage, with a major sell-off of sterling and a rebuke coming from the IMF. The accompanying sell-off in gilts has been huge, as yields soared across the curve, with the 10-year yield peaking at 4.59%, 149bps higher than on 16th September⁽¹⁾. This has been driven by expectations of higher interest rates, and the fall in sterling suggests the risk premia attached to UK assets has risen.

On Wednesday this week the Bank of England intervened to avoid the initial stages of a financial crisis by doing two things. First, it postponed its plans to sell some of its QE gilt holdings, which will now commence a month later than planned. Second, it stated that from the 28th of September until the 14th October it will buy an unlimited number of long-term gilts, in order to ’restore orderly market conditions‘. In other words, the Bank is restarting QE.

Since the announcement, 30-year gilt yields have fallen back from 5.10% to 4.30%, which reverses about half of the recent rise. 10-year yields have also fallen, from 4.59% to 4.15% (1). This has put pressure on the treasury to re-think the changes outlined in the mini budget and has undermined confidence in the management of the UK economy. The finance bill still has to go through Parliament which will mean some interesting debates in the Commons in October.

10-Year Government Bond Yield

Source: Capital Economics

Elsewhere, the Fed has turned more hawkish in the near term, and some commentators think longterm yields will remain around their current levels over the rest of the year. As disinflationary pressures may become more apparent in 2023, many now forecast the 10-year Treasury yield will be 3.75% at end-2022 ⁽¹⁾, higher than previously thought, with a sharp decline over the following two years.

These market moves have been unprecedented in their speed and magnitude and have caused understandable concern for investors. A knock-on effect, which triggered the Bank of England’s intervention, was that many pension funds would have had to raise liquidity and sell bond holdings to cover interest rate derivative positions (effectively raise cash to cover the collateral they need to meet their liability driven investment (LDI) strategies as the value of gilts fell). As an illustration of the size of the falls, the longest dated index linked bond hit a price of £42 on Wednesday; in November 2021 it was nearer £400.⁽²⁾ We believe that the BoE has brought some stability back to the disorderly gilt market and some bond managers are now seeing value in UK government bonds.

For UK investors the events of this week come on top of many other domestic and global uncertainties at the moment, but they are not something that could have been easily anticipated. Both equity and bond markets are reacting negatively to the current problems created by inflationary pressures with no tipping point in sight. The UK has its own specific issues but is by no means alone in the position it finds itself, facing a recession, as monetary policies tighten to beat inflation.

We have never advocated market timing as a solution to avoiding such events and firmly believe that a diversified portfolio of assets is the correct way of investing through these periods of uncertainty. We may indeed face further periods of market volatility as sentiment moves both positively and negatively on news flows, but we should avoid any knee jerk reactions to these changes.

Sources: Capital Economics (28th September 2022) ^[1], Royal London Asset Management ^[2]
 

RSMR
September 2022

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