Mini Budget: 'The straw that broke the camel's back'

Within hours of Chancellor Kwasi Kwarteng's delivery of the fiscal event, sterling crashed almost to parity with the US dollar and has remained weak since.

Justin White, manager of T. Rowe Price US All-Cap Opportunities Equity fund, told Investment Week that a London black cab driver had recently accepted US dollars as payment, calling it "God's currency" amid the uncertainty.

Gilt yields hit decade highs in the following days, landing at 5.2% yesterday (12 October) after the Bank of England confirmed it would end its emergency bond buying programme this week, leaving pension funds days to shore up their liquidity.

UK has made transition to higher rates world 'as difficult as possible'

The central bank intervened in the wake of the Mini Budget in a bid to stabilise the stock market and prevent liability-driven investment (LDI) funds going bust, pledging to buy up to £5bn in bonds a day and even extending this to £10bn at the start of this week.

Ben Conway, director and head of fund management at Hawksmoor, said that the repricing seen in fixed income is "literally unprecedented", calling it the "fastest repricing of real yields in history".

Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, said the central bank "needs to maintain the credibility of independence and not be seen as bailing out the government for reckless policies", but nor can it "stand by" if the bond market heads into a fresh crisis.

She added: "The chances are rising that it will eventually have to dip in again with an urgent intervention unless the government navigates into a fresh U-turn on tax cuts."

Since then, major financial institutions including the International Monetary Fund, Bank of England, S&P and Fitch Ratings have all painted a negative picture of the UK.

Treasury Committee grills BoE on bond-buying expansion

The economic and financial reaction since the Mini Budget was announced is striking, but managers have questioned how much of this downturn was solely caused by the budget itself.

Niall O'Connor, manager of Brooks Macdonald's SVS Defensive Capital fund, said the Mini Budget had arrived when "bank yields had already gone up", with the Bank of England at the time committing to quantitative tightening to try and manage inflation while the Federal Reserve was standing by its hawkish rhetoric.

He described the Mini Budget as the "straw the broke the camel's back" in the world of rising rates.

"Is Kwasi [Kwarteng] really what caused Exxon Mobil to sell off by 6%?" O'Connor asked.

"I do not think it is right to say that he blew up the entire world economy. That seems a bit far-fetched."

At a recent Treasury Committee, the chief UK economist at Deutsche Bank called the markets reaction "a textbook response", explaining that the melting pot of global factors and "idiosyncratic local factors" had created a backdrop of "increased market uncertainty, increased market volatility and increased market illiquidity", meaning that any statement given at the time of the Mini Budget was set to have a larger than usual impact.

Other industry spokespersons echoed O'Connor's stance: Kasper Elmgreen, Amundi's head of equities, said that economic fragility was "everywhere at the moment".

He explained: "You have a situation of economies having been under significant pressure during Covid and they were just coming out from Covid in a reopening and now they are already on the way down due to out of control inflation."

According to him, the scale of reaction experienced in the UK is an "isolated event now, but I think it is very, very likely to be repeated elsewhere" as governments and central banks battle over who will bear the brunt of rising costs whilst trying to engineer growth and quell inflation.

The future of UK gilts

Examining what has occurred in response to the budget, Ben Yearsley, co-founder of Fairview Investing, said the market reaction had been "just a big tizz over nothing".

As Conway explained, the unfunded elements of the budget were not huge relative to the size of the UK's commitments and most of them were flagged ahead of time.

Indeed, tax cuts have now begun to be cancelled, as Liz Truss was pressured to backtrack on scrapping the 45% of top rate of income tax.

Yearsley called the budget "politically naïve" and said putting it out without the OBR report was a mistake given recent events concerning the Conservatives.

He said if Kwarteng had announced the energy bailout, which was urgently needed, and waited for the OBR report, "we probably would not have had this issue".

The full impact of the past three weeks is still uncertain, but Hawksmoor's Conway said there had "almost certainly been a permanent destruction of capital".

He noted that unlike Covid, the UK cost of capital is "probably permanently higher as a result of the poorly handled policy announcement by the government", which had added to weakening sterling, and the "ridiculous volatility" witnessed in gilt markets.

"We all have to get used to living in a world where the cost of capital is going to be sustainably higher," he said.