The biggest mini-Budget in decades!

View from the Trading Desk:

On Friday, the newly minted Chancellor of the Exchequer presented his mini-Budget, with a whopping £161bn price tag, that primarily aims at lower taxes and more public borrowing. If the market reaction is any guide, this policy is viewed as ruinous:

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UK Gilt Yields 21/09/22 and 26/09/22 - Source: Bloomberg

At first glance, our reaction was confusion about the policy choices announced, because they seem to defy basic economic principles, and we feared the UK version of a Recep Erdogan moment (where cutting interest rates brings down inflation). After all, the UK is in a cost-of-living and energy crisis, so it would seem wrongheaded to imagine a tax break for middle and upper classes earners would solve anything. Once you take into account the funding implications of this legislation (an overnight 1.5% increase in mortgage payments), it's hard to see a net benefit. 

The easy, cynical conclusion is that the government is simply shifting this tax burden from wealthy individuals to lower-income workers and future generations. What we suspect is that this is the first of two acts. 

This first scene has created a need for belt-tightening, which sets up a coup de grace of spending cuts in key public services.  

Bottom line: The news couldn't get worse from an inflation perspective. Trade-weighted Sterling has depreciated 4% in the past two days (and over 14% year-to-date), which puts further pressure on import prices. This certainly makes exports more attractive, but some recent articles demonstrate that it hasn't translated into more exports, so the impact is an overwhelming net negative. The Bank of England will likely have to increase the pace of interest rate hikes to offset the inflationary pressures, which should hopefully prevent a further precipitous fall in the Pound. Lastly, a lot of the Budget costings (seeing as we have no OBR review) seem fantastical. 

Some external scoring has the total cost coming in at 190-200bn GBP, which might just make it the most expensive Budget ever.

What concerns us most is how this is being debated in the political sphere, entirely in the context of positioning. 

Unfortunately, Labour doesn't dare to criticize poor policy for fear of being branded 'pro taxes', which makes matters worse. They fell for the trap and will have only themselves to blame when the second shoe drops, and we're talking about mass privatization of public services because we must sort out this deficit which we've created.

 

The week ahead

GBP 

The Pound has taken a beating in the last week as markets take a sour view on new fiscal measures introduced by UK Chancellor Kwasi Kwarteng. Falling over 6% against the Dollar, talk of parity is now a serious proposition after the largest intraday drop since March 2020. This puts the Bank of England at odds as traders price in 150 basis points of increases by November this year, with rates forecast to peak at 6.25% in November next year. Calls for the Bank of England to convene and issue an emergency rate hike are growing as Sterling assets remain highly volatile amid divergence in fiscal and monetary policy. 

  • The Rightmove House Price Index MoM expanded 0.7% in September versus a 1.3% decline in August. 
  • Monetary Policy Committee members Silvana Tenreyro, Huw Pill, Jon Cunliffe, and David Ramsden are due to speak this week. 
  • The British Retail Consortium (BRC) Shop Price Index YoY for September will be published on Wednesday.
  • Final GDP QoQ data is due to be released on Friday for the second quarter of 2022; a reading of -0.1% is expected. 
     

EUR

The Euro has continued its downtrend against the US Dollar, falling 3.5% since the start of last week and 40 basis points so far today. Giorgia Meloni will head the next coalition government in Italy after securing 44% of the vote; the impact on the common currency appears muted despite the formation of the most right-wing government since the Second World War. Fresh Inflation data for the Eurozone will be released this week, with more records expected. This may prompt the European Central Bank to implement a larger hike, but comments from Governing Council members point to 50 basis points as the baseline so far. 

  • The German ifo Business Climate index came in lower than expectations for September at 84.3 versus forecasts of 87.0. 
  • European Central Bank President Christine Lagarde is due to speak today at 2:00PM and Wednesday at 8:15AM. 
  • German Unemployment Change for September is forecast at 20.0K versus 28.0K in August. 
  • Eurozone flash CPI and Core CPI YoY for September will be published on Friday; analysts expect readings of 9.7% and 4.7%, respectively. 
     

USD

Dollar strength continues heading into the final week of September, with the DXY testing the $114 level, a 20-year high. With a 75 basis-point hike by the Federal Reserve last week and further tightening to come, Dollar strength is unlikely to dissipate any time soon. From the recent dot plot, which summarises policymakers' predictions for interest rates, a headline rate of 4% is expected by the end of this year. Such aggressive tightening is unlikely to come without economic pain, spelling further downside in US equities; Goldman Sachs has since slashed its year-end forecast for the S&P 500 to 3,600. 

  • Federal Reserve Chairman Jerome Powell is due to speak tomorrow and Wednesday with other Federal Open Market Committee members also expected throughout the week. 
  • Conference Board Consumer Confidence data is scheduled for release tomorrow; analysts expect a 104.5 reading for September. 
  • US Unemployment Claims for the week ending the 24th of September are forecast at 215K versus 213K in the previous week. 
  • The Core PCE Price Index MoM for August will be released this Friday; forecasts are for a 0.5% read versus 0.1% in July. 

 

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