Investment Insights

Market Vigilantes Force Tax U-Turn

  • Oct 05, 2022
  • Andrew Gillham

There was no shortage of drama in another tumultuous week for global financial markets. UK markets whipsawed amid the fallout of the chancellor’s mini-budget whilst international markets tumbled on concerns of more aggressive central bank measures to tame inflation.

The blue-chip S&P 500 and technology focussed Nasdaq indices extended their declines for September to 9.3% and 10.5% respectively, making it the worst month for stocks since the start of the pandemic in March 2020. The two indices erased the gains made since mid-June and set new lows for the current year.

The pound fell to record low of 1.0350 versus the dollar in the early hours of last Monday morning but a more serious threat to the UK financial system was to follow.

The £45 billion of tax cuts announced in the mini-budget, without any offsetting reduction in public spending, also triggered a sharp sell-off in UK government bonds in anticipation of a huge increase in supply to fund more government borrowing.

The fall in prices was most pronounced in long-dated government bonds, leaving the UK pension system particularly exposed. Pension schemes use derivatives to meet long-term liabilities, people living into old age, and the sudden drop in bond prices prompted a flurry of margin calls as the value of collateral posted dropped.

Pension funds were caught in a “doom-loop”, selling government bonds into a falling market to raise cash, until the Bank of England took emergency action on Wednesday to halt the rout and avoid contagion spreading throughout the financial system. The spike in bond yields, which are used to price mortgages, was already forcing high street lenders to pull a range of mortgage products.

The BoE announced it will buy up to £65 billion of government bonds over the next 13 trading days and it had an immediate impact. The move also restored some confidence in the pound which clawed its way back to where it was trading versus the dollar prior to the bombshell budget.

Opinion polls suggest the historic ructions in markets have undermined confidence in the government and the opposition Labour Party has opened up a 33-point lead according to a YouGov poll. The mini-budget also prompted criticism from the International Monetary Fund and Standard & Poor’s revised its outlook for the UK’s AA-rating to negative on concerns of the trajectory of government debt.

It was also clear the market wasn’t going to stand for the budget in its initial form. No changes meant the risk of another run on the pound and higher government borrowing costs. The chancellor listened and on Monday morning Kwasi Kwarteng acquiesced to ditching his plan to scrap the 45p tax rate for the highest earners. He also pledged to publish the government’s medium-term fiscal plan, outlining measures to keep debt on a sustainable path, by the end of October.

The turmoil across financial markets didn’t deter Volkswagen from pushing ahead with its IPO of a 12.5% stake in Porsche on Thursday. Priced at €82.50, shares in the iconic sports car manufacturer climbed a couple of cents on their first day of trading on the Frankfurt Stock Exchange. The broader German market fell nearly 2% on the same day. VW will use the €9.4 billion raised from the sale to pay a special dividend and to invest in electric vehicle and battery technology.

There was less good news for another auto manufacturer, albeit one at a very different stage in its timeline. Tesla revealed it had delivered a record 348,830 vehicles in the third quarter, a 42% increase from the same period last year, but fell short of the 359,000 forecast by analysts. The electric vehicle manufacturer blamed difficulties securing transportation to deliver cars at a reasonable cost. Tesla shares fell 8.6% on Monday, wiping more than $70 billion off its market value.

Energy markets remained volatile, pushed and pulled by concerns over the health of the global economy and the prospect of OPEC+ cutting production to support prices. The oil cartel will meet in Vienna this week and speculation that they a considering their largest output cut since the start of the pandemic drove Brent Crude prices back up to $89 a barrel.

(Cover Image Source: Chris Liverani)

TEAM Asset Management is a trading name of Theta Enhanced Asset Management Limited which is regulated by the Jersey Financial Services Commission.