Bonds – It Is Like A James Bond Thriller

“Investor uncertainty”, “falling pound”, “promised tax cuts” “funded by government savings” are all familiar phrases which are no longer headline grabbing statements as they have now joined the lexicon of familiar phrases no longer leading to eyebrow raising surprise or concern when we hear the same.

The markets punished the Chancellor, Kwasi Kwarteng, for not setting out his fiscal plan when delivering his mini budget at the end of last month. They believed that if money is not in the coffers of the UK Treasury to pay for the same, the Chancellor will have to borrow and pay more interest in the backdrop of increasing interest rates. At the same time, there is uncertainty in the energy market and a looming recession whereby unemployment may suddenly do a U-turn from its current low of 3.5%.

This nervousness has been seen in the bond market with more ups and downs than a James Bond thriller. It goes to demonstrate the fragility of the UK economy and lack of confidence international investors have in the UK.

To help understand why markets act in this way, it is important to understand that government bonds are issued to raise money to bridge the gap between a shortfall in tax revenue and government expenditure estimated at £60 billion. The UK’s problem is that these bonds are now being resold at a lower value, meaning that the government IOU with a specific return can be purchased at a lower capital figure but with the same return. In the meantime, the government has to continue to borrow and can only issue bonds with a higher interest rate to achieve the same capital return which means the long term interest rates increase. As this cycle continues and the long term interest rate increases, this will feed into mortgages and other borrowing rates.

All this uncertainty is not helped by the governor of BOE, Andrew Bailey, saying last week “the bank does not intend to extend its emergency bond-buying programme beyond the Friday deadline”. However, it is clear that the bank will have no choice but to continue to do this until the Chancellor announces that he has brought forward his fiscal plan and economic forecast to 31 October.

The UK is not the only country to face the spectre of inflation but every country is taking different approaches in terms of monetary policy. The USA has continued to increase interest rates and suck in foreign investment to meet its desire for cash whilst Japan is trying to keep interest rates low to stimulate growth after Covid which has meant a plummeting Yen. The question is in which direction is the UK going to head, is it going to follow Japan or the USA?

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