Political volatility meets pivot chatter

Sterling markets remained front and centre for the month of October, though for all the wrong reasons. After the mess caused by the mini-budget, Kwasi was the first casualty – he tendered his resignation and was replaced by Jeremy Hunt (this means Tories have had more chancellors in 2022 than Labour have had since 1967). At this point, Truss was still “in charge” but as Hunt unwound all of the Truss/Kwasi plans, it began to look a lot like control was slipping from her grasp. And sure enough, with market and popular sentiment turning too far against her, Liz Truss stepped down. After a couple of days of back and forth, including a run from BoJo, Rishi Sunak replaced Truss as the new PM.

Markets have reacted positively to the U-turn on the mini-budget and the Sunak government. As such, GBP has rallied and gilt yield have fallen. GBP rates have had another remarkably volatile month, 5y rates have fallen more than 1% from their highs, and the BoE base rate - expected to peak at 6% last month - is now expected to peak at just under 5%. Though some calm has reappeared, the government’s next budget has been pushed back. Planned for the end of October (and pertinently before the next BoE), the statement will now fall on 17th November. The implication here is that the BoE will be “blind” at the next meeting and any ramifications from Hunt’s budget will not be addressed by the bank until they meet in December.

In Europe, we had an ECB meeting and they hiked by 75bps for the second consecutive time. They commented that inflation remains too high and that higher rates should be expected, but removed language that hikes would continue for “several meetings.” Removal of this phrase was taken somewhat dovishly and future hike expectations were dampened.

Though natural gas prices have fallen in recent weeks, there is concern that inflation has become significantly more broad based, keeping pressure on the ECB to hike. But on the flip side, the ECB is being directly criticised by some politicians for moving rates too far too soon. Most notably, Italian PM Meloni used her first speech to parliament to criticise the rate hikes and even Macron has grumbled about recent ECB action, further highlighting the difficult path being trod by Lagarde et al.

In the US, treasury secretary Yellen highlighted the need for financial stability in the markets. No doubt concerned by what she has seen in the UK over the last month, Yellen espoused the importance of a properly functioning treasury market. Supply in treasury markets continues to climb and certain tenors are becoming increasingly difficult to trade. In response, Yellen has said they are considering more central clearing or even security buybacks (QE carried out by the treasury…). Even the mention of this has caused some in the market to point toward a pivot in sentiment in the US, with inflation perhaps having turned a corner (though still very high).

Is the path ahead a more accommodative one that currently assumed?