Bank of England will wait to rescue the pound

The Bank of England issued a statement in response to the volatility in UK markets following the release of the government’s tax plans at the end of last week. The BoE said it was “monitoring developments in financial markets very closely” and it would make a full assessment of the government’s tax cut plans “at its next scheduled meeting,” seeming to push back against expectations of an emergency meeting. The BoE also indicated it would not “hesitate to change interest rates by as much as needed” to get inflation back to its 2% target.

ECB president Christine Lagarde said the bank would continue to raise interest rates “over the next several meetings to dampen demand” and fight against inflation which is dragging on growth in the Eurozone. Unlike the Fed, which appears committed to getting to a restrictive stance on policy, Lagarde indicated that the ECB wanted to get policy rates to a neutral level and then decide if more tightening was required.

The OECD lowered its projections for global growth next year to 2.2% real GDP growth, down from 3% estimated for this year. Virtually all major economies saw their outlook downgraded with the OECD now expecting Germany’s economy to contract by 0.7% next year while the UK will flatline and the US will manage growth of just 0.5%. The club of developed market economies noted tighter monetary policy to fight against inflation as a major contributor to the weaker growth outlook along with China’s persistence in its stringent Covid-19 response.

Japan’s composite PMI print improved slightly to 50.9, back into the expansion side of the measure after falling to 49.4 a month earlier. The services component led the overall index higher, rising to 51.9 from 49.5 a month earlier while manufacturing held relatively steady at 51. Inflation in Japan remains substantially below peer economies at just 3% y/y in August, even though that represents the highest level since 2014. The Bank of Japan has remained highly committed to an accommodative policy stance though how effectively that is being transmitted to households and firms is diluted by the BoJ’s heavy ownership of JGBs.

The People’s Bank of China has imposed a risk reserve requirement of 20% on currency forwards to help stem the decline in the value of the CNY which has hit its weakest levels since the peak of the Covid-19 pandemic in 2020. China has remained a global outlier on monetary policy, keeping conditions relatively accommodative compared with peers like the US, as the economy slows among restrictive Covid-19 policies and an overall property slump.

The German Ifo Business Climate Index (BCI) recorded a significant fall in September, with the headline value dropping to 84.3 from 88.6 in August. The BCI is now well below its pre-covid (2010 – 2020 Q1) average of  99.3. The decline in the headline index reflects material falls in both the current conditions and future expectations components of the index. At a value of 75.2 in September, the future expectations index is now lower than the levels seen during the 2008 financial crisis. There were also broad-based declines at the sectoral level, with each of the six sectoral indices falling on the month. The Ifo highlighted that responses from relatively more energy-intensive businesses had been particularly pessimistic. With a track record of being a reliable leading indicator of economic growth, the latest data release points towards a sharp contraction in German economic activity in coming quarters.

Today’s Economic Data and Events

• 16:30 US durable goods orders August: forecast -0.3%
• 18:00 US Conference Board consumer confidence September: forecast 104.5
• 18:00 US New home sales August: forecast 500k

Fixed Income

• Benchmark governments fell heavily to start the trading week, extending the losses started last week from the UK’s mini-budget. This time US Treasuries also fell with the 2yr UST yield up 14bps to 4.3406% while the 10yr yield surged 24bps to 3.9244%. The moves helped to narrow the 2s10s spread by almost 10bps to -43bps although with the Fed likely to persist in further hikes, it may widen its inversion later on this year.
• UK bonds were again the main propellant for the explosion in government debt markets with the 2yr gilt yield up 50bps to 4.39% and the 5yr adding 48bps to 4.521%. The 10yr gilt rose by nearly 42bps to 4.236% as markets spurned the Bank of England’s statement that it would only consider intervening at the next scheduled MPC meeting in November. Market pricing is for about 150bps of hikes at the early November meeting.
• European bonds also sold off heavily as uncertainty sets in about the direction of policy under a new right-wing Italian government. Italian 10yr yield added 21bps to 4.536%, pushing their spread over comparable maturity bunds up to 245bps. Bund yields themselves ended yesterday up 9bps at 2.108%.
• Emerging market bonds wilted under the heavy selling pressure with steep drops for central and eastern European debt. In our universe, the 10yr South African yield added 11bps to 11.315% while similar maturity Turkish bonds rose 13bps to 11.39%. Indian 10yrs managed to hold their nerve however, rising over the course of the day.

FX

• All eyes were on cable yesterday which remained under pressure from the government’s new tax cut plans. After a brief drop to 1.035 in early trading, its lowest level ever, the pound recovered somewhat on the hopes of an emergency intervention from the Bank of England, getting up to as high as a 1.09 level before fading later in the day to settle at 1.0689, down 1.6%.
• The weakness in the cable market extended across the rest of the FX space with EURUSD dropping by 0.8% to 0.9609, even as ECB speakers talked up the need to do more tightening of policy while USDJPY added 1% to 144.75.
• Commodity currencies all came under heavy selling pressure with a 1% rise in USDCAD to 1.3735 while AUDUSD dropped 1.1% to 0.6456 and NZDUSD fell 1.9% to 0.5637.
• There was heavy selling across all emerging market currencies as well with CNY hitting elevated levels even as the PBOC has tried to step in to arrest the decline. USDINR added 0.8% to 81.6237 while USDTRY rose 0.2% to 18.4539.

Equities

• Equities extended their sharp moves lower as risk appetite continues to crumble. The Dow fell more than 1.1% while the S&P gave up 1%. The NASDAQ managed to hold up relatively better, limiting its declines to 0.6% .
• European markets were weaker with the broad EuroStoxx down 0.2% though the FTSE managed to stabilize.
• Asian markets have opened mixed this morning with the Nikkei up strongly by nearly 0.7% while the CSI is up 0.2%.

Commodities

• Oil markets remained caught up in the maelstrom of selling with Brent futures down 2.4% to USD 84.06/b and WTI falling by 2.6% to USD 76.71/b. OPEC+ is likely waiting until its scheduled meeting next week before it announces any more production changes, which are only likely to be downward.
• Metals prices also remained soft with gold down 1.3% and copper dropping by 1.2%.

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