Last Chance Saloon

View from the Trading Desk:

The Liz Truss ‘era’ of experimental, head-in-the-clouds politics is over, and not a moment too soon for UK assets which have been routed by the past month’s chaos. Her short-lived premiership finally came undone on Friday as she lost the confidence of the majority of Conservative MPs after a string of policy mistakes. The ruling party is now faced with one final opportunity to place Rishi Sunak, the only fiscally credible candidate, at the helm. After Boris Johnson pulled out of the race late yesterday, markets have begun to price in a Sunak government, with both the Pound and Gilts rallying since the open. Still, let’s not underestimate the size of the economic challenge facing him, along with the urgent need to repair the deep divisions inside the party.

Over 150 MPs have already pledged their support for Sunak, while fewer than 30 have backed Commons leader Penny Mordaunt, boosting the chance that we could see Sunak installed as the next PM as early as this afternoon. If Mordaunt can secure 100 supporters by 2pm, the race might go to an online vote of the Tory members, but the likelier scenario is that one candidate will remove themselves from the race after an internal vote of Tory MPs. Assuming Sunak inherits the keys to Number 10, his first months in charge will almost certainly require both cuts to public spending and tax rises as he tries to fix the damage caused by Truss’s tenure. These policies will no doubt be unpopular with both lawmakers and the wider electorate, leaving Sunak the unenviable task of selling the longer-term benefits to the nation. The former Chancellor will need to draw on his reputation for delivering frank honesty to regain public confidence, with around two years before the next general election must be called.

During the height of the market mayhem between late September and mid October, the government faced a risk premium of around 1% over its European peers, meaning an increase to the annual interest bill of around £20bn by 2025. This has reduced to a negligible level, easing pressure on the Bank of England to deliver more jumbo rate hikes in the coming months. It will also help Jeremy Hunt, if he remains as Chancellor, in his bid to balance the books and reduce debt as a percentage of GDP.

Bottom line: The widespread expectation is for UK assets to continue rising on a Sunak premiership; however, the flip from stimulus to austerity is going to inflict more short-term pain on the economy. Bloomberg Economics has forecasted a 1.4% contraction in the UK economy for 2023, while inflation could peak at 12% in April. In our opinion, risks remain tilted to the downside for Sterling, meaning opportunities to find value in the Pound could be few and far between.

 

The week ahead

GBP 

UK markets are experiencing some relief at the start of this week as Rishi Sunak becomes the front-runner for the Tory leadership contest, following the departure of Liz Truss after just 44 days. UK gilts have rallied in early trade while the Pound gets some much-needed support as markets anticipate the introduction of a more fiscally responsible Prime Minister. Businesses up and down the country are concerned that recent political developments have amplified the economic downturn in the UK as output drops to levels not seen since the Global Financial Crisis. Despite near-term relief, downside pressure on Sterling is unlikely to abate soon as structural drivers such as current account and fiscal deficits coupled with record-high inflation and a negative growth outlook open up the currency to further weakness.     

  • UK flash Manufacturing and Services PMIs for October came in lower than forecasts at 45.8 and 47.5, respectively. 
  • Monetary Policy Committee member David Ramsden is due to testify today at 3:15PM in front of the Treasury Select Committee.    
  • Bank of England Chief Economist Huw Pill will be speaking about the cost of living crisis at an event hosted by the Office for National Statistics tomorrow. 
  • The Confederation of British Industry (CBI) Industrial Order Expectations for October are expected to read -13 versus -2 in September.

EUR

All eyes will be on the European Central Bank this week as markets look ahead to a second straight 75 basis-point increase, with Eurozone inflation sitting at 9.9%. PMI data for the Eurozone came in at worrying levels this morning, with the composite PMI hitting a 23-month low of 47.1 as a recession on the continent begins to look more like a formality. Vast stockpiles and some warmer-than-expected weather have pushed European Natural Gas futures below €100 per megawatt hour, the lowest for four months. This has helped curtail risks of blackouts and energy rationing this winter; European leaders are also more hopeful that the process of procuring supplies outside of Russia will become more reliable by next winter. 

  • Germany’s flash Manufacturing and Services PMIs for October continued their trend lower this morning, reading 45.7 and 44.9, respectively. 
  • Eurozone flash Manufacturing and Services PMIs also printed this morning for the month of October at 46.6 and 48.2. 
  • The European Central Bank will meet this Thursday to deliver its latest monetary policy decision, with an interest rate hike of 75 basis points expected. 
  • On Friday, a number of European countries will publish preliminary CPI data for October; the German CPI is forecast to hit 10.1% YoY. 

USD

Talk of smaller interest rate hikes by the Federal Reserve gathered pace at the end of last week, with Mary Daly now believing that the central bank should start to consider smaller moves. Markets are pricing a 75 basis point move at the November meeting, followed by a 0.50% hike in December, ultimately moving to a terminal rate between 4.5%-5%. These words have been welcomed as Treasury yields move lower across the curve and US equity futures point moderately higher today. The Dollar Index has climbed this morning, while the Offshore Chinese Yuan weakened to an all-time low as widening yield differentials exacerbate inflows into the Dollar. USD/JPY has recovered from its declines on Friday following a suspected $37bn intervention by the Bank of Japan; the pair is trading back above the 149 handle today.  

  • US flash Manufacturing and Services PMIs will be published this afternoon; surveys point to 51.0 and 49.5 prints for October. 
  • Conference Board (CB) Consumer Confidence data for the month of October will be released on Tuesday; forecasts are for a 105.3 reading. 
  • US Advance GDP QoQ for Q3 2022 is scheduled to print this Thursday; analysts are expecting a 2.3% gain in the quarter. 
  • To close out the week, Core PCE Price Index MoM data for September is due to be published; a 0.5% print is the market expectation. 

 

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