It would be nice if we could open our weekly market commentaries with something other than the state of politics in the United Kingdom. Regrettably, that opportunity has not yet come, and we need to start with an attempted explanation of the bewildering events of past seven days.
It is probably best to get the worst bits out of the way first. What we have seen is an unappetising mixture of naiveness, political incompetence and pig-headedness. Arguably the worst of it came at the weekend when the prime minister was alarmingly keen on letting it be known that the 45p thing was all Kwasi and nothing to do with her. The more one dwells on this, the more one has to come to the conclusion that our new PM needs to grow up; and that she needs to do so pronto.
We already knew that the government and the MPC were at loggerheads. The former wishes to grow the economy to prosperity; the latter is intent on inflicting recession on the country in order to quell inflation. Something, as they say, has to give. But if only it were that simple. The loggerheading, though, became a lot more complicated last week. Let me try to explain.
The Monetary Policy Committee has committed to selling the gilts and corporate bonds bought by its programme of quantitative easing. It has set a timetable for what it and others unimaginatively refer to as ‘quantitative tightening’ (or QT), which includes selling an annual dollop of £80bn worth of gilts. This was due to start today. Think again. As you doubtless have seen, the Bank of England (as opposed to the MPC) was forced to intervene in the gilt market as pension funds were forced to jettison their gilts overboard to meet margin calls on their derivative holdings. Ignore the details, the important part is that the Bank has very successfully restored order to a gilt market that was in meltdown. This restoration, though, has been effected by its buying of gilts. The Bank is therefore committed both to selling gilts (by QT) and to buying them (to maintain an orderly market). And no, I do not know how to untangle this knot of Gordian complexity, and which may need an Alexandrian solution.
The past week may have been surreal, though, but it is not without potential salvation. With one big caveat. First, the Conservative Party needs to get through its conference without worsening its unattractive and self-defeating squabbles. Second, the government needs to tell the markets a credible plan for funding its tax cuts. Third, and this is where we come to the caveat, the Bank of England needs to play ball. This last part would require a U turn of Trussesque proportions. The Bank – specifically the MPC – appears adamant that we can only be cured of inflation by losing our jobs and our houses. Recession is to inflation as garlic is to Dracula, in the eyes of the MPC.
It should be that the storm has blown over, pro temps, although there will still be some heavy showers. Markets are well in in front of the Banks and are already pricing in both significantly higher interest rates and a large economic downturn. We are seeing what should be pockets of tremendous value in both equity and bond markets. It is likely, though, that this value will become even better before markets have the confidence to turn round. That will be when they sense that the Banks will be forced to admit that they have overdone the tightening (or claim victory against inflation, dependent upon one’s perspective).
We should also touch on the vulnerability of UK-based companies. American balance sheets are, by and large, very strong. Domestic growth is slowing and vulnerable to more rate rises by the Federal Reserve. The dollar is at levels rarely seen versus sterling (and almost all other currencies, to be fair). It is a mixture that appears to make overseas acquisitions uniquely attractive. The UK may even have an advantage in attracting capital, in having started to free itself from aspects of European regulation. All that is needed is confidence in political stability.
This column has always striven to be politically neutral. It is unavoidable that it will appear otherwise, probably quite frequently. Political parties and governments are prone to say and do some pretty stupid things at times, and we will make the point when this is relevant to the markets. On rare occasions, political parties may also say, or plan, something that is strangely sensible. We should therefore give at least a little nod of appreciation to the Labour Party (possibly for the first time) for revealing the outline of what might be an entirely plausible energy policy and transition towards net zero. We have long argued that this should be a source of huge opportunity for the economy, something that Labour seems to have twigged. There is also a wider implication, if Labour is heading towards the next election in the very strange situation of having an economic policy supported by large chunks of the City.
Finally, congratulations to those who knew the opening line to Dire Straits’ Money For Nothing. Today, I think this was top of the hit parade when I started gainful employment, so from what assault on one’s ears does this come: “Ahh, baby. My heart is full of love and desire for you”?
Jim Wood-Smith – Market Commentator and Head of Climate Transition
All charts and data sourced from FactSet
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