Rishi Sunak: “I’d rather lose than win on a false promise.”

September has been a remarkably depressing month for the Brits. Not only have they had to say goodbye to Queen Elizabeth II, for most the only monarch they’ve ever known, but they’ve also had to watch the demise of two other age old and quintessentially British institutions, the Conservative Party and the Bank of England. Both have sustained heavy blows to their credibility recently after triggering a run on Sterling and Sterling assets. The latter has fallen far behind the curve in its fight against inflation, but arguably the finger of blame for the current rout can be squarely pointed at the former, with the Bank of England left to clean up the Government’s mess after newly appointed Prime Minister, Liz Truss, and her newly appointed Chancellor of the Exchequer, Kwasi Kwarteng, delivered a ‘mini-budget’ in name and not by nature.

On top of the energy price cap, which could cost up to£150 billion (~6% of UK GDP) if there is no end to conflict in Ukraine and gas prices stay high over the next two years, Kwarteng announced a further £45bn of unfunded tax cuts. If only the Conservative Party membership had listened to the previous Chancellor of the Exchequer, Rishi Sunak, when he ran against Liz Truss for Party leadership and warned about the perils of wild and reckless tax and spending plans at a time of great uncertainty for the British economy.

UK Government bond yields have subsequently soared, forcing the Bank of England to reverse course on its quantitative tightening plans in order to support the gilt market with purchases instead, whilst the value of the British Pound has plummeted, prompting former US Treasury secretary, Larry Summers, to forecast Sterling’s fall to below parity with the US Dollar as stagflation (high inflation and low growth) becomes entrenched into the economy. Friday 23rd September was the third worst day for Sterling (-3.6%) since Black Wednesday in 1992, with the worst two coming after the Brexit vote in 2016 (-8.1%) and initial covid shock in 2020 (-3.7%) when there was a global flight to safe haven US Dollars.

Leaving an era of ultra-low interest rates was always going to be economically hazardous for the UK. However, Putin and Kwarteng have combined to make the speed and quantum of the rise in interest rates more traumatic. Put simply, the 6% mortgage rates we are seeing in the UK today would equate to around two-thirds of the average borrower’s monthly disposable income, and could be the catalyst for a housing market collapse if the situation worsens. It is a truism that governments lose elections rather than oppositions winning them, and in this case for the 2024 general election, Liz Truss may have just done that in record breaking time.

Economic data continues to moderate, raising the probability of a recession over the next 12 months. Inflationary pressures are broad based but many cyclical components are decelerating from their post pandemic highs. The Federal Reserve continue with their hawkish narrative and remain committed to prioritising lower overall levels of inflation. The labour market is still running hot but conditions are gradually easing, as labour supply rebounds and job openings slow from a record peak.

The ECB is also strengthening its resolve to combat historically high inflation levels. Recession risks in Europe are primarily geopolitically driven, as high gas prices and elevated uncertainty are exerting a toll on the Eurozone. The Italian snap general election was won by the Brothers of Italy led by Giorgia Meloni, a radical far right party with neo-fascist roots, but with only 26% of the vote are now likely to form a centre right coalition government.

Economic data continues to moderate with the consumer fading as the cost of living crisis continues to weigh. Inflationary pressures remain elevated with many fearing the Bank of England is behind the curve, with the recently announced ‘mini budget’ adding to an uncertain economic and fiscal outlook with largest tax cuts since 1972.

Japan’s economic recovery has lagged behind other major economies, but its long-term trend growth rate is amongst the lowest in the G20. Yen weakness worries some policymakers with headline inflation hitting 8-year highs. The central bank is notably out of step with its counterparts in North America, Europe, and Australasia where significantly tighter monetary policies are in motion, mounting substantial downward interest rate differential pressure on the Yen.

The Chinese economy continues to be weighed down by its ailing property market, which is experiencing its worst period on record, all exacerbated by the government’s zero Covid policies. Monetary (interest rate cuts) and fiscal (wider deficits and VAT rebates) stimulus continues. Unlike in western economies this year, Chinese inflation pressures have remained benign, leaving the People’s Bank of China as the only major global central bank to cut interest rates and ease financial conditions in 2022. The 20th National Congress of the Chinese Communist Party will be held in October, where President Xi Jinping is looking to secure a third consecutive five-year term.

A big driver of economic and market performance in EM and overall economic conditions in general is the strengthening US Dollar, which has so far in 2022 strengthened the most in a calendar year since 1984 (DXY Index). Inflation surprises in EM have turned more two-sided in recent months. Broadly, EM financial tightening pressures, which started earlier than many advanced economies, may possibly have peaked.

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