Weekly Brief: The Name’s Bonds. Crashing Bonds.

Weekly Brief: The Name’s Bonds. Crashing Bonds.

over 1 year ago4 mins

Investors didn’t think much of the UK government’s sweeping new tax plan at first, and upon further reflection, they liked it even less.

🕰 Recap

  • A little over a week ago, the UK government announced a series of big tax cuts that threaten to fuel the country’s inflation and balloon its debt
  • That caused a major selloff in UK assets that went into overdrive on Monday after the government doubled down on its stance over the weekend
  • The Bank of England was eventually forced to intervene and rescue the bond market on Wednesday and avert a catastrophe for the UK’s pension funds

✍️ Connecting The Dots

Britain's drama started on Friday, September 23rd, after the UK government announced a series of tax cuts that threaten to further fuel inflation – already at 40-year highs – and balloon the nation’s debt. Those fears immediately sent the pound tumbling more than 3% to hit its lowest level against the dollar since 1985. What’s more, the tax cuts – which are set to cost as much as £161 billion ($176 billion) – will be financed by new government borrowing that comes on top of the additional debt needed to fund the prime minister’s plan to freeze households’ energy bills. A huge borrowing spree at a time when interest rates are rising is not a good combo, and that pushed investors to also dump British government bonds, sending their prices plummeting.

The selloff in UK assets went into overdrive on Monday after the government doubled down on its stance and hinted at even more tax cuts to come. At one point on Monday, the pound had tumbled almost 5% to hit a record low of $1.035. The crisis caused some traders to bet that the Bank of England (BoE) would step in with emergency rate hikes to stem the pound’s bleeding, but they were quickly disappointed when the BoE rebuffed the suggestion that same day.

The BoE was eventually forced to intervene on Wednesday, pledging to buy unlimited amounts of long-term government bonds to rescue the market and avert a catastrophe for the UK’s pension funds. See, with bonds collapsing, pension funds – which hold truckloads of the asset – were facing huge potential losses. That prompted brokers to ask for more collateral to cover those potential losses in what is known as margin calls. If pension funds had started selling off investments to raise cash, it would’ve hit bond prices even more and sink the market altogether. And if they couldn’t meet their margin calls, they’d go broke, hitting thousands of Brits’ hard-earned pensions.

✍️ Takeaways

1. The UK’s policies are contradictory in every sense.

The UK has a serious inflation problem but the BoE’s and government’s policies are at complete odds with each other. The BoE is (rightfully) hiking interest rates to lower demand and tame inflation. The government’s tax cuts, however, have an opposite effect: they’re likely to lead to increased consumer spending and higher inflation. Making matters worse, the BoE’s emergency actions this week – buying unlimited amounts of long-term government bonds using newly minted money – are set to flood markets with cash and could add more fuel to the inflation fire.

2. The government’s plan to freeze energy bills is getting costlier.

At a price tag of more than £130 billion ($142 billion), the government’s plan to freeze households’ energy bills was never cheap and is only getting costlier as the pound tumbles. See, the UK depends on oil and natural gas imports for most of its energy needs, and those commodities are priced in dollars. So as the pound sinks against the greenback, the country’s energy import costs are rising, which means that the government will have to borrow even more to fund its plan.

🥡 Also On Our Radar

Trading volumes in NFTs have tumbled 97% from a record high in January this year. They slid to just $466 million in September from $17 billion at the start of 2022, according to data from Dune Analytics. The fading NFT mania is part of a wider, $2 trillion wipeout in the crypto sector as aggressive interest rate hikes around the world inspire investors to ditch their riskier assets.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG