Shane O'Neill, Head of Interest Rate Trading
It is rare in rates markets that you have a month including 3 central bank meetings in which all banks hike and none of the actions come close to being the story of the month. That honour goes to Liz Truss, Kwasi Kwarteng, their mini-budget and the fallout that followed.
Announced in the mini-budget were a raft of tax cuts: removing the top rate of tax altogether, reducing stamp duty, freezing corporation tax, amongst others. When it became clear that these were to be unfunded (and with no associated spending cuts forthcoming) the market entered panic mode. The potential deluge of additional gilt supply caused a sell-off of some 50bps in the 5y tenor on Friday, followed by a further 45bps sell-off on Monday. The scale of the move was historic, the Friday move was the largest 1 day move since 1985 and the rolling 5day move, the largest seen since 1976. Hike pricing changed dramatically, with a non-zero probability of an inter-meeting emergency hike being priced in on Friday and base rate reaching >6% by May 2023.
At the same time, we saw GBP tumble against the USD, falling to all time lows of under 1.04. When rates shoot higher and currency tumbles, it is easy to make the case that the market in question is an EM. Intraday volatility was huge on both Monday and Friday, and this continued Tuesday, when 5y rates opened some 20bps lower before moving 55bps higher to close at post-crash highs. With the pound crumbling and rates markets in disarray, there were calls for BoE intervention – though they released a statement on Monday evening, they refrained from active intervention. That was until margin calls began to threaten some of the countries largest LDI (pension, insurance funds) institutions. With derivative hedges in place which protect against lower rates, the sudden increase in rates saw MtM losses skyrocket and funds considering liquidating assets to meet the calls. On news of this, the BoE announced a postponement of gilts sales and the restarting of QE! This scare shows both the current fragility in the financial markets but also, pertinently to risk managers, the critical importance of appropriate liquidity management (as we have recently discussed here). The UK story is far from over and attention now turns to November, when we will hear the government’s plans for keeping borrowing under control (spending cuts…) and we will get and independent review of the plans from the OBR.
Across the pond the Fed meeting saw the third consecutive 75bps hike and was accompanied by a Powell presser which the market read as hawkish. Chairman Powell said the FOMC would move rates “purposefully to a level that will be sufficiently restrictive to return inflation to 2%,” and they released a dot-plot with rates reaching 4.6% in 2023 – higher than their previous release. Not to be outdone, the ECB hiked by 75bps themselves this month. Although Lagarde claimed this wasn’t the new norm, recent inflation data out of Germany has several members calling for another 75bps in October and the markets now expects that to happen.
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