Expensive election promises to torpedo UK bond market
With the abandonment of social democracy, you get two things – Neoliberal capitalism on the right and socialism on the left. Neither has proven to work. A fully functioning political and economic model should keep a good grip of the extremes. It ensures that markets are not rigged, that price discovery dominates, that there is a symbiotic relationship between nationalisation and privatisation. In Britain, social democratic economic models are no longer functioning as they should.
Today, politics in Britain has not been as divided as this since that start of WW2. But they do agree on one thing and one thing only – that besides Brexit – fiscal largesse is central to re-election. This is a blow to trickle-down economics, the dream of Thatcherism has gone too far and blown itself apart.
And all these promises being made on both sides also promises something else – that the UK’s very strong bond market is seriously threatened. Gilts that are beating Treasuries and bonds this year suddenly look vulnerable. Aggressive asset managers like JPMorgan Asset Management, BlueBay Asset Management and Nikko Asset Management think so. The money managers cite this election with all of its big-money promises as the main reason for concern.
Bloomberg reports that – “BlueBay and Nikko are taking short positions in the U.K. rate market; Nikko for the first time since Britain voted to leave the European Union in 2016. They reason that no matter which party emerges victorious in December, the era of fiscal austerity is over.
Much of the money for ambitious spending plans of both parties is likely to be borrowed, hitting the bond market with a wave of issuance. At the same time, prime-the-pump policies to boost growth could create inflation that erodes bond returns. Stimulative fiscal policy “implies higher deficits, and therefore much more bond supply,” said Mark Dowding, the chief investment officer at BlueBay. He’s holding bearish positions in gilt futures and sterling interest rate swaps and said he sees the 10-year benchmark climbing to as high as 2% “over time (currently 0.73%).”
The giveaways don’t come cheap. To name just a few – Labour are promising a green industrial revolution, a big push in NHS spending and nationalising rail and even internet services. The Tories have announced increases in payments to universal credit, NHS and social care, strategic road and rail infrastructure investment, 20,000 extra police officers and cut business rates for shops, pubs and cinemas.
Then there’s the unfolding disaster represented by HS2 at cost of £88bn, expected to exceed £100bn and the nuclear facility at Hinkley Point set to cost over £22.5 billion.
In the 2009-2010 fiscal year, when the U.K. sold a record 227.6 billion pounds of bonds to steer the economy out of recession, yields actually dropped by an average 75 basis points.
Britain is headed to the polls in an election aimed at breaking the Brexit deadlock. While uncertainty remains high, bond bears have become more confident that it’s no longer a one-way bet for gilt yields. They expect the new government, whoever it may be, to use fiscal stimulus to support a fragile economy that will weaken with yet more uncertainty.
It was only last week that Moody’s Investors Service placed the U.K.’s Aa2 rating on negative outlook, saying the country’s ability to set policy has weakened in the Brexit era along with its commitment to fiscal discipline.
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“Fiscal stimulus will have to be deployed whatever the outcome” – said Grant Peterkin, a portfolio manager at Manulife Investment Management. He’s betting on higher long-term yields and trimmed a long position in U.K. bonds.
The influx of new debt will be a bigger factor in yields than during the post-crisis years when safety was tantamount, according to Seamus Mac Gorain, head of global rates at JPMorgan Asset Management.
There are other factors that complicate a bet against bonds. The U.K. only just dodged a recession ahead of the now-postponed Oct. 31 Brexit deadline, but the weakest growth in almost a decade and inflation at a three-year low is keeping the tone dovish at the central bank, with some of its policymakers ready to deploy support. Michael Saunders and Jonathan Haskel at the Bank of England voted for an immediate rate cut from 0.75% at the meeting this month.
However, uncertainty is the biggest problem. It is stemming investment in the country. Productivity and output will inevitably fall. Even if Boris Johnson gets a good majority and the markets see a better chance of an orderly Brexit – nothing is stable.
Given that Johnson still needs to put a compelling case to the House of Commons and push through his version of the Withdrawal Bill (that WILL be contested), he still has to negotiate a trade deal with the EU by December 2020 – a feat that averages seven years not six months. And as yet, the government, whoever or whatever that turns out to be – have not yet decided what that deal should look like. Will it be aimed at the EU or the US? Brexit will take years to negotiate and organise.
Ian Dunt at politics.co.uk – “So basically, it isn’t going to happen, not for years. Brexit won’t be done. We’ll be in the same hellscape of tribalism – of culture war in a technocratic straitjacket – that we’ve been in for the last three years. With a new set of artificial timetable cycles and all the repeated national humiliation that entails.”
Britain is now in the unenviable position of facing an economy it needs to prop up with money it does not have, borrow at more expensive rates, pay out rising bond yields – whilst speculators bet against it and investors run for the hills.