Over the past three weeks, the UK has provided the world with more “lessons to be learned”, in Bank of England-speak, than any market since the US in 2008.
Entire textbooks will come to be written about the stunning scenes in the UK’s usually sedate bond markets since the “mini” Budget of September 23, with chapters entitled “Government policymakers: Don’t Do This” and “Or This”.
One of the key lessons that investors would be well advised to heed is that central banks really, truly mean it this time. They do not care how much money you are losing, even if global stocks are down 26 per cent this year without the usual counterbalance of higher returns from bonds.
They simply cannot be blown off course from a relentless rise in interest rates to quash the inflation they first failed to see coming and then swore was a blip. They are not in the mood for doing anything to foster moral hazard or to risk pushing inflation even further from their targets.
To recap on the UK for anyone lucky enough to have missed it: markets were looking grim globally, with inflation proving sticky and most big central banks slamming on the monetary brakes.
On September 23, Kwasi Kwarteng — who was the chancellor when I started writing this column before he was sacked — stepped in with a “mini” Budget that included the biggest unfunded tax cuts in 50 years and a huge increase in borrowing, all predicated on growth assumptions that had not been subjected to independent external scrutiny.
UK government bond markets recoiled, prices fell fast and technicalities relating to hedging strategies meant certain pension funds had to sell more. The BoE halted this spiral by offering to buy gilts off them, later backing that up with further measures to enhance liquidity and buy inflation-linked bonds for a period ending on Friday.
This had all already provided more excitement for gilt market veterans than, well, ever. But a fresh shock came late on Tuesday this week, when BoE governor Andrew Bailey said he was serious: this support really will end on Friday. No rollovers of support.
Investors are hard coded, from the past decade and a half, to believe that temporary assistance has a magical way of becoming semi-permanent, that central bankers will look after them. But speaking at an event in Washington, Bailey was blunt. “We’ve announced we will be out by the end of this week. My message to the [pension] funds is you’ve got three days left,” he said.
This went down like a cup of cold sick. My phone lit up with messages in frankly unrepeatable terms asking what on earth the BoE governor was up to. The consensus was that disaster lay ahead. In fact, it turned out to be a master stroke. All of a sudden, take-up of the central bank’s bond-buying facility shot up. Market participants realised they could not wait and hope for the BoE to buy bonds off them at a better price. They had to get it done — this really is not a form of backdoor monetary support.
Against the odds, the central bank managed to get the market under control and cap what was looking like a disorderly ascent in yields. Any form of more lasting prop to market stability is likely to be very narrowly targeted.
“[The BoE] didn’t want anyone to think they were getting bailed out,” says Tomasz Wieladek, an economist at T Rowe Price. “The bar for central banks to pivot is very high” given red hot inflation, he adds.
This is precisely the sort of tough love that investors must learn to live with. To quote the peerless Björk (no ridiculous quibbling on her immense talents will be entertained, so please don’t bother emailing me): Your rescue squad is too exhausted.
Some fund managers are finding it easier to adapt to this new reality than others. Ark Investment Management’s Cathie Wood — the doyenne of growth stocks and a champion of innovation — is in the latter camp, perhaps unsurprisingly for someone whose flagship exchange traded fund has fallen 63 per cent this year. This week, she penned an open letter to the US Federal Reserve “out of concern [it] is making a policy error that will cause deflation”.
Wood sounded exasperated at the Fed’s latest 0.75 percentage point rate rise, asking “Unanimous? Really?” Three days after her letter, annual US inflation was reported to be running at 8.2 per cent, just a shade below the previous month’s reading of 8.3 per cent. It is reasonable to wonder why aggressive rate rises are not yet showing any discernible success in pulling down inflation. But the answer has to be “yes, really”.
The Fed does not operate in a vacuum. “Several participants noted that . . . it would be important to calibrate the pace of further policy tightening with the aim of mitigating the risk of significant adverse effects on the economic outlook,” it said in its latest meeting minutes.
But that is nowhere close to a serious suggestion it is considering a more lenient path. Bad news for economies and real life is often good news for markets, as it suggests central banks might be more generous to the financial system. But it is increasingly clear that we would need a truly dire shock for that to work now.