Yahoo Finance UK bonds swing as traders scrutinise new chancellor Jeremy Hunt
UK bonds have swinged sharply after Kwasi Kwarteng was sacked as the government announced yet another U-turn on the mini-budget and named Jeremy Hunt as the new chancellor.
Liz Truss has run back on her campaign promises and announced a corporation tax increase. The U-turn is has caused some volatility as gilts started rallying hard only to slump after Truss' press conference.
Government borrowing costs on debt due to be repaid in 30 years fell on Friday morning, but then climbed back up, to 4.56%. They had hit 5.17% on 28 September in the aftermath of the mini-budget.
Liz Truss said she would stick with plans first announced by Rishi Sunak to increase the rate of corporation tax from 19% to 25%, and not continue with the plan to to keep it at 19%, which would have made it the lowest rate in the G20.
The swing comes as investors are nervously awaiting an impending deadline for the end of the Bank of England's (BoE) emergency bond-buying programme.
The BoE is set to stop its government bond-buying scheme this Friday after the central bank stepped in last month to buy bonds to relieve pressure in the £2trn UK pensions sector.
“Should the Bank of England step away from the market today as suggested, we could see gilt yields rising, and the feedback loop of selling of gilts – as pensions schemes struggle to maintain hedges – reassert itself," said Chris Arcari, head of capital markets at consultants Hymans Robertson.
The now former chancellor Kwasi Kwarteng’s unfunded £43bn tax-cutting plans in the mini-budget last month led to a surge in yields on gilts, UK government bonds, amid a sell-off due to scepticism from large swathes of the markets.
This pressure caused the BoE to step in to calm the gilt markets by promising to buy up to £65bn in gilts from those who want to sell them.
The government issues bonds to raise money for public spending, often used to service pension funds and the life insurance market.
Read more: Liz Truss reverses plan to scrap rise in corporation tax in another U-turn
The price – or rate – at which they are bought and sold is linked to risk and confidence. If investors believe a government has a strong financial footing that will allow them to repay the debt on time, then the risk is low and the price is also lower.
The opposite is also true, so if markets think a government will not be able to pay on time they will charge a higher price for that risk.
So when confidence in the UK economy falls, the bond price inversely shoots up.
Amid this turmoil, some funds linked to pension schemes, which invest in bonds, were forced to start selling, sparking fears of a fresh market downturn.
However, despite the end of the programme, government bonds and the pound have steadied this Friday, with trading sentiment boosted amid speculation that the mini-budget will be reversed.
“Gilt yields fell as investors speculated Truss and Kwarteng will be forced into a humiliating U-turn on tax cuts. There is not the same fear as there was a couple of days ago when Andrew Bailey laid down the law and said funds have three days to get their house in order.
Read more: Pound pares losses as Jeremy Hunt appointed chancellor after Kwarteng sacking
"Given the Bank is maintaining a hard line, we think that the market is moving on expectations that the government will back down or seek to soothe markets somehow.
"Could this be a false hope? Kwarteng and Truss are thus far holding the line and we only have vague speculation about a U-turn. The political reality, however, will bite sooner or later. I think this weekend will be ‘interesting’,” Neil Wilson, chief market analyst for markets.com, said.
“After a roller-coaster week that saw the pound plummet a couple of days ago, sterling has gained strength once again," said Naeem Aslam, chief market analyst at AvaTrade, said.
"The main reason that we have seen bulls coming back in the market is mainly the fact the current government, which has its reputation completely torn, perhaps didn't think things through.
"Now, the government is taking steps back in relation to its fiscal policy, and it has started to scrap parts of the budget; the sterling has started to recover."
“One important thing to keep in mind in relation to the sterling is that the Bank of England will be pulling out its support today and this means that the bond market will be left alone. Now, a real test will begin and if the yield on gilts remains stable, we could see even more recovery in the British pound,” he added.
Read more: Interest rates: Bank of England chief economist hints at 'significant' November rise
Kwarteng cut short a trip to Washington to return to London and was supposed to work on a new fiscal plan but ended up being sacked.
At this stage, the nation is asking if his tax cut plan or his job are toast, potentially both,” Russ Mould, investment director at AJ Bell, said.
“Always look at the bond market if you want to know what the smart investors are thinking, and a drop in gilt yields on Friday tells you one of two things. Either the Bank of England is hoovering up gilts sold by pension funds (pushing up the price and pulling down the yield) before the end of its support measures today, or markets believe the chancellor is going to rip up his mini-budget and start again. The smart money is probably on the latter,” he added.
Mel Stride, the chair of parliament’s Treasury select committee, said that Liz Truss must not “nibble at the edges” but instead perform a “powerful” and “significant” U-turn with its so-far disastrous economic plan.
Read more: How record high US inflation can hit UK markets, the pound, and 'Trussonomics'
“My personal view is that it [a U-turn] should happen, we have reached a point where we need this very powerful and significant signal to the markets that fiscal credibility is firmly back on the table, and I think that means doing something right now and not delaying.
“Doing something very significant too – right at the heart of that will be unwinding the position on corporation tax.
“The danger here is the argument in the room lands in a place where they decide to nibble at the edges of this and I’m afraid I don’t think that will cut it, and you could end up in that circumstance in the worst of all worlds where you’ve U-turned but doesn’t settle the markets in the way we need to,” he told the BBC’s Today programme.
Although the emergency bond buying programme will come to a close today, other two additional measures — the Temporary Expanded Collateral Repo Facility (TECRF) and the expansion of the collateral eligibility set for the Indexed Long Term Repo operations — will not be terminated.
TECRF is aimed at enabling banks to help ease liquidity pressures on liability driven investment (LDI) pension funds via liquidity insurance operations.
The Indexed Long Term Repo operations will also allow funds to borrow cash from the BoE in exchange for handing over assets as collateral.
The end of the BoE's emergency bond-buying programme is due to end at 4.30pm this Friday.
Watch: Bank of England to stop government bond-buying scheme today
