Suspicious minds leave UK assets all shaken
By Andy Bruce
LONDON (Reuters) – Britain’s new finance minister, Kwasi Kwarteng, has trouble ahead: A marked change in the behavior of British assets in the markets indicates growing unease about vulnerabilities in the economy.
Investors around the world have generally taken advantage of the weak pound in the past to snap up UK stocks and government bonds.
But that hasn’t been the case recently, as the FTSE 100 stock index and gilts have moved in step with the pound, unlike the Brexit vote of 2016, when the pound’s fall lured buyers , for example.
GRAPHIC-UK assets have moved in sync with the Pound recently…: https://fingfx.thomsonreuters.com/gfx/polling/movanebyxpa/Pasted%20image%201663143613600.png
GRAPHIC-…but they usually move in the opposite direction, like after the Brexit vote: https://fingfx.thomsonreuters.com/gfx/polling/jnvwemkbwvw/Pasted%20image%201663143911264.png
The new trend turned brutal in August, the first time since 1983 that the pound fell more than 4% against the dollar and the 10-year gilt rose 50 basis points.
In contrast, the inverse relationship between the euro and German equities and government bonds remained largely intact.
While all major currencies have slid against the rising dollar in recent months, the pound has fallen more than most.
The synchronicity of UK assets suggests investors are avoiding them, reflecting worries about the economy.
Britain’s heavy reliance on energy imports is likely to mean that inflation – which hit a 40-year high of 10.1% in July and only eased slightly in August – will last longer than elsewhere. For the first time on record, UK fuel imports accounted for more than 20% of the value of all merchandise imports in July.
New Prime Minister Liz Truss’ hugely expensive plan to subsidize energy bills in combination with deep tax cuts to spur economic growth at a time of rising prices – and her stated desire to rip the economic orthodoxy – reminiscent of the policies of the early 1970s that contributed to spiraling inflation.
Kwarteng, appointed Chancellor of the Exchequer last week, defended the new government’s plans, saying Britain has more room to borrow than other countries which have a higher share of public debt compared to economic production.
Reviving growth is the best way to obtain higher tax revenues that will restore public finances in the medium term, he says.
But investors are once again focusing on Britain’s main economic vulnerability: its dependence on foreign funds to finance its balance of payments deficit.
The current account deficit from January to March hit a record 8.3% of economic output, although statisticians said changes in post-Brexit data collection could have skewed the figures.
“Fiscal and external risks are now, in our view, a primary concern,” said Benjamin Nabarro, economist at US bank Citi.
Former Bank of England Governor Mark Carney said Britain was relying on the “kindness of strangers” to finance its current account deficit, most of which stems from the trade deficit.
When Carney made this comment in early 2016, foreign direct investment accounted for about half of net financial inflows from abroad.
Today, those FDI flows have turned sharply negative in net terms, leaving more volatile stock and bond sales as Britain’s main way of financing its current account deficit over the course of the month. past year.
GRAPH-Financing of the UK current account deficit: https://fingfx.thomsonreuters.com/gfx/polling/egpbkrbqbvq/Pasted%20image%201663144170918.png
Citi’s Nabarro said the changes in the markets will not have escaped the notice of the BoE’s monetary policy committee, which will see declining investor confidence in UK assets as an unwanted complication in its fight against inflation and could leave higher interest rates for longer.
“We suspect that at least some committee members watched the simultaneous selling of sterling and gilts without much concern,” Nabarro said. “In our view, these risks should increasingly be at the center of political discussion in the UK.”
Investors are awaiting the government’s costs for its new package of energy bills which Dutch bank Rabobank says could mean £100bn of additional borrowing. Others say it could be more.
“That’s a lot to ask,” said Stefan Koopman, senior macro strategist at Rabobank.
“There is a risk of a funding strike, which to some extent has already manifested in the form of a weaker currency.”
Jim Leaviss, chief investment officer of public fixed income at M&G Investments, said he was underweight gilts.
“There’s a concern about debt sustainability relative to other countries… There’s a huge wave of gilt issuance coming in and it’s going to be an overhang in the market,” he said. he said Tuesday at an M&G conference.
A test of the appetite for gilts is expected to take place next week when the UK Debt Management Office is expected to offer some of the 30-year bonds via a syndicated sale.
Longer term, the pound may need to fall further to attract investors.
Dean Turner, an economist at UBS Wealth Management, said the potentially unlimited liability of taking on gas bills weighed on investors. “Until we get some clarity on this, I just don’t see the situation turning around,” he said.
Kwarteng is expected to deliver a budget statement to parliament next week which could include those funding details.
Not everyone avoids UK assets. Morgan Stanley said Friday that long-term gilts are a buying opportunity relative to German bunds, as a lot of worrying fiscal news from Britain is already priced in.
But many investors remain worried.
“It’s hard to avoid the conclusion that a UK sovereign risk premium has entered the pound – likely due to doubts about the price at which investors would be willing to fund future UK borrowing plans,” Antoine said. Bouvet, ING rate strategist.
(Additional reporting by Dhara Ranasinghe; Editing by William Schomberg and Toby Chopra)
