Posted On Sep 30, 2022

It is a month in which all market participants, whatever asset class they trade, know they have to be on their guard and if Liz Truss and Kwasi Kwarteng did not know this they certainly do now following a tumultuous week.

September has a deserved reputation for being a troublesome month in financial markets.

It was, for example, the month in which Black Wednesday saw sterling ejected ignominiously from the Exchange Rate Mechanism in 1992 and the month in which Northern Rock collapsed in 2007.

By then, the global financial crisis was well under way, an unfolding disaster that reached its most frightening moment with the collapse of the US investment bank Lehman Brothers in September 2008.

Pound falls again as Truss and Kwarteng issue statement - economy latest

So it is a month in which all market participants, whatever asset class they trade, know they have to be on their guard.

It is unlikely that Liz Truss and Kwasi Kwarteng, both of whom worked in business before going into politics, would not have known this.

If they did not, the new prime minister and chancellor certainly do now, following a tumultuous week.

For most people who may not necessarily pay attention to events in financial markets, the wild gyrations have been best summed up by the pound, which even before Mr Kwarteng's ultra-expansionary budget last Friday had fallen by 16% against the US dollar since the start of the year.

Sterling promptly tanked last Friday as investors took fright at billions of pounds worth of unexpected borrowing and finished the week at $1.0856.

The rout picked up pace in Asian markets in the early hours of Monday morning when most Britons were asleep, sterling plunging to a new all-time of $1.0382, a level surpassing even the $1.054 hit on 25 February 1985.

The pound rallied after London opened and continued to grind higher on Tuesday, with the Bank of England's crucial intervention on Wednesday in the gilt market helping it to further gains that day and on Thursday, although it has sold off again today on news that Mr Kwarteng will not be bringing forward, as many would have liked, his medium term fiscal plan from 23 November.

Nonetheless, sterling goes into the weekend having clawed back the majority of losses it has racked up since the chancellor's mini-Budget.

The same cannot be said for gilts.

The yield (which moves in the opposite direction to the price) for government IOUs rocketed last Friday and continued to climb during the first half of the week.

Then came Wednesday and the Bank's decisive move to buy what is eventually expected to be £65bn worth of 20- and 30-year gilts after those particular assets had been subjected to forced selling by pension funds when strains emerged due to a hitherto obscure part of the sector known as liability driven investing (LDI).

Yet the Bank's intervention - restricted to 20- and 30-year UK government debt only - has only partially repaired the damage.

The yield on two-year gilts (a good indicator of where the market thinks short term interest rates are heading) hit 4.761% on Tuesday morning - a level last seen in August 2008 - and at the time of writing was still above 4%.

To put that into context, before Mr Kwarteng began speaking last Friday, it was just under 3.5%.

These are huge moves by the standards of these assets.

Similarly the yield on the 10-year benchmark gilt, which had been just under 3.5% before the mini-budget, had blasted to 4.582% at one point on Wednesday before coming off slightly.

It remains above 4%.

Only in the 20- and 30-year maturities, where the Bank has been active, is the yield back to levels approaching where they were a week ago.

These numbers matter.

They are not just arcane figures that should only be of interest to traders and investors, but should matter to us all because gilt yields represent the implied borrowing costs for the UK government.

Original Post: UK economy: September financial curse strikes again - and beware of October economic horrors