Global equities moved lower last week with the MSCI All Country World Index dropping 2.5%, extending September’s decline to 9.5% and the year-to-date loss to just over 25%. This marked the worst monthly loss for the index since March 2020.
US equities broadly tracked global stock markets with large-cap benchmarks posting a slightly larger weekly decline (-2.9%) but faring slightly better for the month of September (-9.2%) and 2022 (-23.9%) thus far. For UK-based investors in US stocks, sterling’s depreciation year-to-date has provided a significant cushion to any losses, with the pound ending last week down around 17% against the US dollar in 2022, near the 1.12 level.
UK markets continue to exhibit heightened volatility, although there are some encouraging signs that some sense of calm has returned following the fallout from the recent “mini-budget”. Two events have helped to restore some confidence in UK assets; first the Bank of England’s (BoE) decision to take emergency action to support the government bond market and secondly, chancellor Kwasi Kwarteng’s U-turn on the abolishing of the top rate of income tax for the highest earners -although this U-turn is only expected to reverse around £2bn of the £45bn announced tax cuts, it is more the symbolism associated with it that has helped to re-establish credibility somewhat.
Gilt yields spiked higher at the start of last week as investors began to question the credibility of the new government’s fiscal plans, but they came back down sharply, particularly at the long-end, after the BoE announced a £65bn bond-buying programme. The central bank pledged to buy up to £5bn of long-dated bonds a day for the next 13 weekdays, as well as suspending its programme to sell gilts.
A vicious circle of selling gilts to meet cash demands
The move came after pension funds had been caught in a vicious circle of selling gilts to meet cash demands from creditors, forcing gilt prices even lower. A number of pension funds were reportedly in serious danger of insolvency, particularly those that hedged exposure to defined benefit pension schemes – a process known as liability-driven investment, which can be especially sensitive to large moves in gilt yields.
The intervention resulted in the largest daily drop in the UK 30-year gilt yield since at least 1992, just a couple of days after the largest increase in yield over the same time period. The UK 10-year gilt ended the week at 4.08%, up 26 basis points but considerably lower than a peak above 4.5% before the BoE intervention.
The currency markets also experienced sizable moves with the pound falling to its lowest ever level against the US dollar, below 1.04, at the start of the week, before recovering to end the week up by over 3%. Despite the recovery in sterling, UK large-cap benchmarks, which find an appreciating currency a headwind, outperformed mid-cap equivalents on the week, with the former falling by around 1.7% and the latter off by 4.4%.
While the BoE stepped into the bond markets, they refrained from an emergency interest rate decision. Since the announcement of the “mini-budget”, derivatives markets have been pricing in that the central bank will have to move faster and further than previously thought with its hiking cycle. By the next monetary policy meeting in November a further 120 basis points of hikes are priced into the current base rate of 2.25%.
Although this represents a large amount of tightening it is significantly less than the 200 basis points priced in just after the tax cuts were announced and the terminal rate, that is the high point for this hiking cycle, is now seen around 5.6%, compared to a recent peak of roughly 6%.
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