Intervention by new UK Chancellor Jeremy Hunt calms markets

Jeremy Hunt, the UK’s new Chancellor, announced yesterday (17/10/22) that he would reverse most of the measures announced in his predecessor's 'mini-budget'. Only a few of the original policies of Kwasi Kwarteng – sacked by Prime Minister Liz Truss on Friday – now remain, including a £13bn cut to National Insurance and £1.5bn worth of changes to stamp duty.

Of roughly £45bn of tax cuts announced three weeks ago in the ‘mini-budget’, almost £32bn have now been reversed. In addition, measures to protect UK households from soaring energy costs, initially put in place for two years, have now been limited to six months and so will only cover this winter. The Treasury will review support again in April, but Hunt said there would be a ‘new approach’ designed to target help at those most in need.

Why has this happened?

Hunt's appointment was designed to restore confidence in the government and its ability to manage the public finances. Kwarteng’s original measures had alarmed markets and triggered unprecedented volatility in sterling and UK government bonds, because they would have significantly increased UK government debt when market confidence was already fragile. As a result, yields on UK government debt rose sharply and sterling dropped substantially against the dollar.

What’s the impact?

Investors welcomed Hunt’s announcement yesterday. The question now is whether the measures will restore confidence for the longer term. Scaled back government spending will mean lower growth, but also lower inflation and this will reduce pressure on the Bank of England. In analysis released on Sunday, Goldman Sachs had already revised down its estimate for where the UK Bank Rate will peak, from 5.0% to 4.75%. Goldman expects 0.75% hikes in November and December, followed by a 0.50% hike in February and two 0.25% hikes in March and May.

UK Gilts have been extremely volatile since last month’s announcement of tax cuts and help for households with their energy bills. The measures announced by Hunt yesterday were designed to restore market confidence, and government bonds reacted favourably. The yield on Britain's 10-year Gilt dropped almost 40 basis points yesterday to 3.95%. The yield on the 30-year Gilt was also down around 45 bps to 4.32%, heading for its second-biggest daily drop on record, and the 20-year Gilt yield was down around 45 bps to 4.41%. The UK equity market also responded positively, with the FTSE 100 up 0.9% at the end of the day and the FTSE 250 up 2.76%. Markets globally were also buoyed by the news.

What are we doing?

We continue to position portfolios defensively, with a preference for short-duration bonds, which tend to perform better on a relative basis in a rising interest rate environment. However, we have been increasing our exposure to interest rate risk for two reasons. Firstly, the bond market is now pricing in all expected interest rate rises and secondly, bonds tend to perform well as recession risks rise. From an equity standpoint, we have added several equity income funds to portfolios. This is due to their ability to provide superior downside protection in volatile market conditions. We also like the fact that equity income funds tend to invest in well-run companies with good capital discipline and strong balance sheets. In addition, speaking very broadly, these companies tend to experience lower fluctuations in profits in a recessionary environment.

The market moves triggered by the Kwasi Kwarteng ‘mini-budget’ have highlighted how volatile markets are at present. We appreciate such market conditions can be unsettling. But volatile markets also create attractive opportunities for long-term investors.

Looking ahead, we are anticipating opportunities in a range of asset classes. However, we are also expecting further volatility, so, to smooth the investor journey, diversification will be key – underlining the benefits of a multi-asset portfolio approach.

Nathan Sweeney, Deputy CIO of Multi-Asset, Marlborough - 18/10/22

Risk Warnings 

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