Market Overview|Quilter Cheviot

Hunt reverses bulk of mini-budget

Market Overview from Quilter Cheviot

By Alan McIntosh, Chief Investment Strategist

United Kingdom politics continues to dominate financial markets, with prime minister Liz Truss replacing Kwasi Kwarteng as chancellor of the exchequer with Jeremy Hunt, a former health and foreign secretary. The move represents a dramatic U-turn in fiscal policy, with the majority of the unfunded tax cuts announced in last month’s mini-budget now set to be reversed and the energy support package made significantly smaller.

In an emergency move, the new chancellor announced the scrapping of £32bn of unfunded tax cuts, over two-thirds of the £45bn his predecessor promised on 23rd September. The move is an extension of a reversal which had already begun after the PM rowed back the decision to keep corporation tax unchanged and cut to the top rate of income tax, accounting for a combined £21bn.

New measures from Hunt include foregoing indefinitely the £6bn cut in the basic income tax rate from 20% to 19%, reversing the planned tax change on dividend income and scrapping a VAT-free shopping scheme. Of the raft of measures previously announced, only a £13bn national insurance cut and a £1.5bn stamp duty reduction remain.

At 38 days, Kwarteng’s tenure makes him the second-shortest serving chancellor, and his resignation came just three weeks after his announcement of a mini-budget sparked outsized swings in UK government bond markets and sterling. The decision to replace Kwarteng and return to more orthodox fiscal policies is a pretty obvious attempt to restore market credibility and there has been a recovery in gilts and the pound since the news broke.

Pressure is mounting on Liz Truss despite efforts to distance herself from the highly unpopular mini-budget and her role is becoming increasingly tenuous. It now appears very unlikely that Truss will survive as prime minister until the next general election, which must be held by late 2024. Under current rules the process for selecting a replacement would simply be a repeat of how Truss became PM, that is Conservative MPs select their two favourite candidates who would then go to a run-off vote from party members.

From start to finish this would take around two months and current party rules dictate that a vote of no-confidence cannot take place until she has completed a year in office. However, rules can be changed – and likely will be – if her position becomes untenable in the eyes of MPs and party members. Appointing a third prime minister since 2019, two of whom would have assumed the role with no popular mandate, would no doubt lead to strong and wide-ranging calls for a general election that may prove too hard to resist.

Should there be a general election, current polling points to a clear and sizable majority for the Labour party and, if correct, would see the Conservatives suffer huge losses. Therefore, it appears an unfavourable time to send Britons to the ballot box from a Conservative perspective, but there could be an element of strategic thinking supporting such a move. The next couple of years are widely seen as incredibly challenging for government and perhaps there is an argument to be made that, from a Conservative point of view, it would be preferrable to let the Labour party deal with it and then return, not tarnished from the forthcoming problems, for the subsequent election.

Yields on UK gilt markets retreated from 14-year highs last week after the government backtracked on some of its controversial fiscal policy changes. Replacing Kwarteng with Hunt has aided the recovery into the new week and the UK 10-year gilt yield had fallen back below 4% on Monday morning, down from a peak of more than 4.5% less than a month ago. The pound has also stabilised from its recent weakness, ending last week slightly higher against the US dollar at 1.12.

Inflation remains stubbornly high

The eagerly anticipated US inflation data last week failed to provide much solace, with the consumer price index (CPI) coming in higher than expected at 8.2% year-on-year. While this is down from a peak of 9.1% in July’s release, the core reading rose to 6.6% to hit a new 40-year high. Although the sharp rise higher in price pressures seems to have abated, elevated levels of inflation are proving sticky, raising concerns that inflation will not return to Federal Reserve target levels anywhere near as quickly as many had hoped.

Persistently high readings contain a further issue in that they can lead to the entrenching of higher future inflation expectations, as evidenced by the University of Michigan inflation expectations gauge rising to 5.1% for the month of October, after three consecutive monthly declines.

Despite the bad news on the inflation front US stocks ended the week off their lows, perhaps suggestive of a fair amount of bad news already being in the price. Thursday, the day of the CPI release, saw the largest intraday move in US large-cap benchmarks since the height of pandemic-induced market turmoil in March 2020. Indices initially fell by around 2% before reversing sharply higher, ending the day up 2%. These gains were pared on Friday, leaving the benchmark with a weekly decline of 1.5%, a little less than the MSCI All Country World Index’s 1.9% loss.

The US dollar index rose slightly last week, with the bulk of the gains due to another push higher in the USD/JPY rate, which rose from 145.30 to 148.70 on the week – a new 32-year low for the Japanese currency. The Bank of Japan intervened in the currency markets last month when the exchange rate moved above 145.90 but this level has since been breached following US inflation data that makes a Fed pivot anytime soon look increasingly unlikely.

The 20th Communist Party conference in China has got underway with president XI Jinping expected to extend his powers for a third term after the conclusion of the week-long congress on 22nd October. China has delayed the release of keenly awaited third quarter economic data, including the gross domestic product (GDP) growth figures, which were scheduled to be released during the conference. The Chinese economy has struggled in recent months as a severe property crisis has taken hold and the reluctance to break with a “zero-Covid” policy has significantly curbed economic activity.

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