What A Difference A Week Makes

Week Ending 21st October, 2022

Following the appointment of Jeremy Hunt, you’d be fooled into thinking that was the end of the UK’s political turmoil. Instead, another shock announcement rocked the country on Thursday.

Meanwhile, the US Fed refused to rule out raising rates beyond 4.75% if inflation continues to accelerate. Plus the UK’s recent pension crisis could be as contagious as COVID, as the US Fed faces a similar predicament.

Skybound Wealth are always on hand to guide you through market volatility and political uncertainty. Whilst we continue to advocate taking a long-term view on your investments, our weekly market commentary is designed to highlight key developments of the previous week.

UK Update:

What a difference a week makes. In a nutshell, the Home Office minister (Suella Braverman) resigned following an IT infringement. Straight after that, Liz Truss herself resigned! A new PM will be in place by this coming Friday, maybe even sooner. Contenders will need the backing of 100 Conservative lawmakers just to be in the running. This time, it will not go to party members. Meanwhile, candidates to be in the running are Rishi Sunak and Penny Mordaunt. You simply couldn’t make this stuff up. Script writers must be scratching their heads.

What of markets? Since Jeremy Hunt took over as the new Finance Minister, both GBP and 10y Gilts have stabilised. Gilts are still some 0.40% above their pre-Liz Truss appointment level. Once we get a PM who can steady the ship and play the part of a steady, boring leader, I think that final, extra risk premium will subside leaving us with normal economics – which still remains dire. This week saw inflation rise back above 10% y/y while retail sales fell again, this time a hefty -1.4% m/m to -6.9% y/y (Aug: -5.6%). Core sales (ex. Fuel & vehicle sales) were also down -1.5% m/m to -6.2% y/y. Key things to note: net PSBR (borrowing) hit £19.25bn on the month, the second highest on record since records began (1993). Higher debt servicing cost was the main reason - despite a £7bn rise in tax revenues. Overall, in the current financial year (April ’22 to March ’23), total borrowing is £72.5bn, some -26% less than a year ago. To cap it all, there’s spending tightening and tax rises to come in the month-end main budget. Recession beckons into 2023!

From The US:

A very chilling comment from Neil Kashkari (Minneapolis President and one of the most senior Fed members) - The Fed can’t halt rate hikes when its benchmark reaches 4.5% to 4.75% if underlying inflation is still accelerating. “We keep getting surprised on the upside... if we don’t see progress in underlying inflation or core inflation, I don’t see why I would advocate stopping at 4.5% or 4.75% or something like that. We need to see actual progress in core inflation and services inflation, and we are not seeing it yet”. “I’ve seen very little evidence in my region that the labour market is softening... the main issue I hear from businesses small and large is that they’re struggling to find workers, how they’re having to pay more wages to keep their employees and to attract employees”.

Can anything derail the mighty US$?

Yes - though not anytime soon. The 10y now stands at 4.24% while the 30y fixed-rate mortgage at 7.37%. Housing sector affordability is at an all-time low while the shelter, food and medical components of core inflation are red hot. The worry is around its debt pile and mounting debt servicing costs – and the resulting impact on liquidity (or rather lack of) given the sheer scale of quantitative tightening taking place. Until now, the Fed has been able to be hawkish given the country’s much lower reliance on energy from outside its own borders, plus the USD is the global reserve FX. However, with total federal debt to GDP at 137% and its budget deficit to GDP -16.7%, the Fed is not finding it easy selling Treasuries as they let bonds mature on its balance sheet and not reinvest the proceeds. SLR (Statutory Liquidity Regulations) mean commercial banks are not buying Treasuries. Foreign entities are selling them too.

We are seeing a reversal of the good times – in good times, foreign central banks accumulate Treasuries (and other assets); during bad times (recession), they sell down. Foreign entities own some $7.5tn in Treasuries. So with few takers and plenty of sellers, it doesn’t create a good liquidity environment. So rather like the BoE, the Fed could well find itself having to become net buyers of Treasuries to prop up the market. Otherwise, we get a repeat of the pension crisis that hit the UK these past few weeks. US Pension funds also have to match their liabilities.

As I said, for now, I don’t see anything happening any time soon. The USD has not hit its peak yet – in fact, it looks several quarters away from it. Historically, the USD weakens when activity hits a low – we are not there yet. Additionally, history shows the Fed would need to be entering an easing cycle. Based on the above perspectives of Fed members, we are not there either.

A market rout driven by a nasty sell-off, by holders of Treasuries, that results in very poor liquidity will be catastrophic. This loss of confidence could send the USD tumbling. What currencies would benefit? Go back to basics: CHF, Gold, Art…

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