On 23 September 2022, chancellor Kwasi Kwarteng unveiled the Truss administration’s ill-fated mini-budget. The measures, which included a raft of tax cuts, aimed to kickstart economic growth but investors – worried rising inflation would run rampant – pulled their cash out of the UK, plunging the gilt and LDI markets into a tailspin.
One year on, Portfolio Adviser has asked industry commentators whether there was any lasting impact in both UK equities and gilts, and how they view investing in the region over the longer term.
Susannah Streeter, Hargreaves Lansdown head of money and markets, said the event “sparked a wave of apprehension about the UK’s economic prospects”, with investors “baulking at the fast and loose plan for big tax cuts to stimulate spending at a time when inflation was running amok”.
She said: “Britain was compared to an emerging market, turning itself into a submerging market, so the price of gilts plummeted and yields jumped – reflecting the premium investors were demanding to hold UK government debt. The firestorm of uncertainty saw a further seeping away of confidence in companies listed on the FTSE 100, pushing the index below the psychologically important 7,000 mark.”
Following weeks of unrest in both the markets and parliament, Kwarteng resigned as chancellor on 14 October and was replaced by Jeremy Hunt, who wasted no time in reversing the budget in almost its entirety.
Streeter added that the change in chancellor – and then prime minister – helped to calm markets, adding: “U-turns, resignations of Kwarteng, then Truss and the appointment of a new Chancellor in Jeremy Hunt did help calm the turmoil and bit by bit more confidence was restored, helping bolster gilt prices and helping the FTSE 100 gain rapid ground.
“But the recent stubbornness of inflation, even without the Trussonomics tax cuts, has taken investors by surprise. This has caused another summer spike in pessimism about the UK’s prospects, putting fresh upwards pressure on gilt yields and stopping the FTSE 100 regaining the highs above 8000 reached in February 2023.
“Liz Truss is still banging the tax cut drum from the back benches, but despite inflation creeping downwards it is still more than three times above the target, so her demands are likely to get short shrift. While stimulus may well be needed to boost a struggling economy, long-term investment to increase Britain’s infrastructure and competitiveness is more likely to help Britain regain its mojo.’’
Allspring Global Investments global fixed income manager Lauren van Biljon said that while the BoE did well to “short-circuit” the forced sale spiral engulfing gilt holders in the aftermath of the budget, the government has struggled to recapture the full confidence of local and international investors.
She added: “I think the assessment most would make is that UK political risk is higher than it was a decade ago – not just due to the mini-budget, but it’s part of a wider pattern. And that’s an issue in a world where investors can look globally for their preferred mix of yield and safety.”
Long term impact
One year on from the fiscal event, Aviva Investors multi-asset portfolio manager Dean Cook said there appears to have been minimal long-term economic damage from the affair.
He said: “Last year’s mini budget is unlikely in itself to have had a long-term material impact on the fortunes of the UK equity market.
“In the immediate aftermath the gilt market cheapened relative to other sovereign bond markets, and we saw a 70bps widening in UK borrowing costs relative to the US.
“That premium has mostly dissipated now, even if international investors may be more cautious about potential future government policy missteps. Data from the Office of National Statistics shows that foreign ownership of gilts dropped slightly over the last year to March 2023.
“There appears to have been minimal economic impact from the episode, and it would be fair to conclude that the recent slowdown in the housing market can be more readily attributed to the BoE’s subsequent rate hiking cycle than the mini-budget.”
One lasting impact, however, came in the liability-driven investment (LDI) market.
Cook added: “The rise in yields materially lowered the liabilities of pension schemes and moved many into surplus, allowing corporate sponsors to move towards scheme buyouts. Arguably the mini-budget accelerated this trend and removes a large amount of demand for gilts from the market.
“This presents the government with a challenge given the UK’s large funding need, the size of its fiscal deficit (around 5.5% of GDP) and the BoE’s ongoing programme of quantitative tightening (QT) removing further support from the market.”
On the Aviva multi-asset team’s current gilt positioning, he added: “We have maintained a position in gilts, centred on the 10-year point of the curve, for most of this year. There is growing evidence that the UK economy is slowing faster than other large economies, which likely puts a cap on how high interest rates can go. This view is beginning to percolate into markets, best evidenced during July when June’s inflation data were published.
“The data came in lower than expectations and saw a distinct flattening in the yield curve, contrary to prior periods where inflation data implied no material slowing the economy and rates up moved in a parallel fashion. We cannot say exactly when rates will peak, as that will depend on future inflation and related data.
“But relative to other markets, the UK is now closer to the biting point where higher rates cannot necessarily be sustained. For multi-asset portfolios, after a difficult year, these changing circumstances have improved the outlook for gilts.”
Hit to international reputation?
Taking a more international perspective, Alison Savas, investment director at global asset manager Antipodes Partners, said: “The UK mini-budget was a hit to credibility and while we have moved on, it did expose structural vulnerabilities in the UK economy around twin deficits and negative feedback loops into inflation via a weaker currency which policy makers have found difficult to address.
“Interestingly, the US is facing a similar issue of funding fiscal excesses with the deficit forecast to reach 6% of GDP next year – the largest since 1946 outside of the 2008 financial crisis and Covid – with a question mark over the price at which this will be funded, but the market is taking this in its stride at least for now.
“Today, UK equities are priced at 11x forward earnings – the cheapest in the developed world and a 20% discount to its own history, versus the US at a 15% premium. The UK is an import dependent economy and as a result inflation has been stickier than the rest of the developed world, and this is weighing on sentiment and valuations.
“Our view is that inflation can fall much faster than the market expects because China is experiencing deflation. We see core goods inflation falling close to zero by year end which can drive UK headline CPI closer to 3.5%. This gives the BoE wiggle room.”
She added: “The preconditions for the market to price in a much more positive outlook are in place, and we have been selectively adding to the UK via Diageo, Tesco and NatWest. These are dominant franchises that are mispriced relative to their business resilience and growth profile, and are very cheap compared to peers listed in other markets.
Gilts ‘great long term value’ at current levels
Assessing the current state of the bond market, David Roberts, head of fixed income at Nedgroup Investments, said: “It could be argued that a slightly higher ‘risk premium’ is required to hold gilts, however disaggregating that from higher inflation and supply – with the BoE mandated to reduce its balance sheet by £80bn this year – related yields is extremely difficult. Further, international demand for gilts has not noticeably dipped.
“At current levels, gilts look great long-term value if the Monetary Policy Committee and US Federal Reserve stick to their 2% inflation mandates. Any hint of a relaxation to those targets and gilts, if not particularly vulnerable on the downside could certainly fail to generate the capital gain many believe is inevitable.
“Add in a rise in commodity prices and a fall in the value of sterling in recent days and the scene is set for base rate to remain higher for longer than many expect. Our view is total returns for investors in gilts will be positive in the next few years. However, the majority of that return will come from the yield – the income – rather than from material upward movement in prices.
“Executive summary – worth it for a buy-and-hold investor, but you might still get a slightly better buying opportunity and for active managers the buy or sell decision short term is more finely balanced than those claiming a “once in a generation opportunity” would have us believe.”