Markets react to political turmoil in the UK

• UK politics remain a driving force for market conditions after British prime minister, Liz Truss, fired her initial chancellor of the Exchequer, Kwasi Kwarteng, in response to the vociferous market rebuttal to plans to massively cut taxes without any commensurate cuts to public spending. Jeremey Hunt, who has served as both foreign and health secretary in previous Conservative governments, has been named as the new chancellor as indication of a move toward the Conservative centre and a plan to balance any tax cuts with public spending rationalization. From the fiscal policy side of the government, credibility in the Truss administration will be slim at this stage and markets will likely assume any policy measure will be resisted by her own party members, let alone the broader scope of British politics and markets. The dismissal of Kwarteng came as the Bank of England closed its emergency intervention to support gilt markets though the open at the start of the week will give an indication of how much confidence markets have that the Bank of England can indeed resume tightening policy.
• Xi Jinping, China’ president, has stuck to the country’s zero-Covid policy in an address to the Chinese Communist Party Congress. President Xi noted that the policy had “protected the people’s health and safety to the greatest extent possible” while it has had a negative impact on China’s economy as whole cities have been locked down for relatively moderate outbreaks of the virus. President Xi is likely to be re-elected for a third term during the congress and he commented that “high-quality development is the top priority” for the economy and that China will hit peak carbon emissions in “line with the principle of getting the new before discarding the old.”
• In the US, consumer confidence improved for October, according to a measure by the University of Michigan. The consumer confidence index rose to 59.8 from 58.6, likely helped by what had been up to now lower gasoline prices compared with where they had hit earlier in the year. While the index has ticked up from a low hit in June, it remains weak by historic standards of the last 30 years as high prices, high interest rates, weak equity markets and a slowing economy all weigh on sentiment. The softness in fuel prices may also prove short-lived as oil markets are set to tighten in coming months. Elsewhere in the US, retail sales were unchanged in September.
• Egypt’s finance minister, Mohamed Maait, said on Sunday that the country has finalised staff-level agreement with the IMF around the terms for a new deal after ‘significant progress was made across all policies’. Maait was talking at the sidelines of the IMF event in Washington, where IMF chief Kristalina Georgieva also said on Friday that all ‘big policy issues’ had been resolved. Egypt first went to the Fund for a new programme in March but the two parties had failed to get an agreement over the line to date. Maait said over the weekend that the IMF was ‘keen on exchange rate flexibiity’, but also on providing ‘social protection and assistance to the segments of society affected by the inflationary wave.’

Today’s Economic Data and Events

• 16:30 US Empire manufacturing August: forecast -4.3

Fixed Income

• US Treasuries extended their slump last week as markets accepted that any near-term pivot toward more accommodative policy has been put paid by persistently strong inflation numbers in the US. Yields on the 2yr UST added almost 19bps last week to 4.4959%, adding 3bps on Friday alone, while the 10yr UST yield added 14bps to close the week at the 4% handle, adding 7bps on the day.
• James Bullard, president of the St Louis Fed, said that the Fed could bring some of the planned hikes for 2023 into this year, perhaps setting markets up for a 75bps hike at the December meeting after expectations for a 75bps hike at the November FOMC. Markets are pricing in a peak in the Fed funds rate at near 5% mid-way through 2023.
• Bond markets in the UK didn’t find much to be enthused about with a change in chancellor at the end of the week with 10yr gilt yields closing up 13bps to 4.325%. How markets respond to the lack of Bank of England support in the open will be crucial to set the tone for broader UK assets over the week. Elsewhere, European bonds closed weaker with 10yr bund yields up 15bps last week to 2.343%.

FX

• Currency markets closed the week softer against the US dollar though moves over the five days were relatively split. The broad dollar index managed to gain about 0.5% on the week, helped by a 0.2% drop in EURUSD to 0.9722. GBPUSD rose over the week by 0.78% though markets slumped on Friday as the change in chancellor caused more worry than reassurance. Sterling settled at 1.1172. USDJPY added 2.4% over the week to settle at 148.67, the weakest level for the yen in the last 30 years.
• Commodity currencies crumbled under the dollar strength with USDCAD adding 1.1% to 1.3885 while AUDUSD dropped by 2.8% to 0.6199 and NZDUSD fell by 0.9% to 0.5562. China’s reaffirmation of a zero-Covid policy will weigh acutely on trade and commodity oriented economies.

Equities

• US equity markets fell once more on Friday following the surprise jump on Thursday in the wake of the worse-than-expected inflation print, and while they didn’t pare quite all of the gains of the previous day, it was sufficient to see the S&P 500 and the NASDAQ down by -1.6% and -3.1% w/w. By contrast, the Dow Jones managed to hold on to a 1.2% w/w gain but with earnings season looking like it might disappoint for some important stocks, markets will likely remain under pressure this week.
• In Europe, the UK’s FTSE 100 ended the week down -1.9% w/w despite gains on Friday as assets were buffeted by economic and political turmoil. The index is down a comparatively modest -7.1% ytd in local currency terms however, a shallower decline than its European counterparts. The CAC and the DAX closed up 1.1% and 1.3% respectively on Friday compared to the previous week, but the two indices are down -17.1% and -21.7% ytd still.
• In Asia, the Shanghai Composite gained 1.6% w/w but the Nikkei lost -0.8%.

Commodities

• Worries over global demand overran concern that supply will fall flat in coming months as oil prices dropped last week. Brent futures fell 3.1% on Friday alone to close the week down 6.4%, while WTI fell nearly 4% to USD 85.61, capping a weekly loss of 7.6%. China’s persistence in maintaining a zero-Covid policy won’t win much love in the oil and broader commodity markets though there may be a downside limit on how much worse Chinese oil demand could get.
• Gold prices settled on the week down almost 3% at USD 1,644/troy oz, battered by the seeming relentless rise in US Treasury yields. Silver and palladium had far wider moves—down 9% apiece—as the industrial outlook worsens. Aluminium forwards strengthened last week as markets expect restraint on Russian supplies.

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