Hi guys, firstly wanted to say a huge thanks to everyone who replied to my request from my article earlier this week - If you didn’t get a chance to send your thoughts do so here:

Alright, let’s get into it.

Hard To Truss Liz…

Kwasi Kwarteng Uk Chancellor to the left, Liz Truss UK PM in the middle

Over the past week the Uk has been in an absolute frenzy across financial markets. The Bank of England recently stepped in to purchase long dated government bonds, all in hopes to restore order and full functionality in Uk markets after the markets revolted at the Chancellor’s tax cut plans which triggered heavy outflows in capital from the pound and Gilt market.

Usually you would blame markets for ‘overreacting’ or just being out of touch with reality. However, this scenario, this was a regrettable mistake from the government. Such that the Tories (Conservatives) have had internal conversations debating whether Liz Truss should remain Prime Minister or if she should be ousted.

As it stands the Bank of England have committed to purchasing £65billion worth of UK bonds to sweep out calamity in Uk markets which caused gilts to soar 100bps and sent sterling to $1.03.

Uk Gilts Spreads Widening

“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability”

— Bank of England

What’s funny is that the Bank of England was due to start their process of quantitative tightening (QE) by now (1st Oct ‘22) but have been forced to postpone the sale to October 31st. As it stands the BoE’s balance sheet holds £838 billion worth of gilts!

Circling back to Liz Truss, after watching markets crumble the PM and Chancellor made a U-turn in policy, admitting their faults in delivering a helping hand to the wealthy. We’ve since seen a recovery of some sort in the pound back to the $1.11 handle.

Chart 1: Cable Spot Rates

The Uk Is At The Epicentre Of A Crucial Trade-Off Between Inflation & Economic Stability

The trade-off between fighting inflation and the damaging consequences of those actions is becoming increasingly visible, especially within the Uk.

Chart 2: Uk's Government Deficit vs Revenue '22

For those looking at this figure and thinking; 'What on earth is the Uk Government doing?’, you’re not alone.

When looking at this, the message to derive is simple, with the planned increase in expenditure (deficit) investors fear the Uk will not be able to manage the increased debt levels which would come at a premium due to the current rate environment; but more importantly the biggest hit comes from investors loss of faith and credibility both within the Uk government and economy as a whole to surface this cycle into the unknown.

Just taking a look at Uk Gilts says enough…

Chart 3: Uk Bond Yields

The question one has to ask is, at what point does the yield on gilts become attractive?

Or is the risk/reward profile not worth the investment?

Goodbye Oil Longs?

When it comes to global growth, there's a few commodities I like to keep my eyes on that tend to signal periods of global expansion and contraction.

  • Crude Oil

  • Copper

  • Iron Ores

You may argue there are a few more or something along those lines but these three metals are great indicators of global expansion and contraction within the economy. Even as consumption becomes more digital, we still require commodities to make digital consumption available. 

Chart 4: USOIL Spot Exchange

A mix of global macroeconomic events have pinned oil prices below the $100 mark and now below the $90 per barrel handle. On going tensions between Russia-Ukraine are causing investors to question their global outlook as supply chains remain constricted, Putin opening the conversation to nuclear weaponry and the explosion of Nord Stream 1 and 2 pipelines.

Not only that, but the ever-growing presence of a deep global recession underpins any hopes of a global growth linked commodity rally.

Chart 5: Copper Spot Exchange

As energy prices remain elevated we’re seeing the likes of copper/growth related commodities take a backseat for the remainder of the year.

So is the oil long over?

Not just yet.

Two days ago, Russia and Saudi Arabia announced a 2-million barrels a day cut in oil production. Aim of the game? Prop up oil prices once again after the most recent downward trend for the commodity.

Central Banks vs Inflation

If we’re being honest, central banks have had their fair share of a beating this year. The constant upward revisions of CPI figures, terminal interest rates and lower growth expectations have led to a difficult path they must travel.

Hike until something breaks. That’s it

Chart 6: ECB & The Fed Policy Path

Markets are suggesting the Fed may have to push rates all the way to 4.25% before being forced to cut down to 4.00% to react accordingly to markets. What does this suggest?

Much tighter, much longer. That’s the message we’re receiving from nearly all central banks as the global economic picture worsens.

The Federal Reserve is making it evident that a hawkish Fed is what we will see until inflation is on a steady decline, the issue is, by the time the inflation figure begins to normalise we would have tipped into a recession. Which means one thing, will the Fed reduce the tightness within the economy or will the Fed keep conditions materially tight throughout the period of weak economic data?

It’s hard to say now, as we have seen with the Bank of England there is no telling what any central bank will do. However, there comes a point where you have to let the market be-rid of all excess capital and wealth creation accumulated through the goldilocks period we had from 2020 until now.

The ECB are on the same mission, the main concern is that through the raising of interest rates, fragmentation risk also becomes more of a concern. For those who aren’t familiar with this term let me explain:

Within the Eurozone, fragmentation risk is the widening of sovereign spreads in some countries within the EU as the monetary policy system leads interest rates higher. The risk here is that as rates across the Eurozone increases, so does the refinancing costs involved with each and every country, even the vulnerable ones like Italy particularly. To factor for this risk investors require a ‘risk premia’ and as this process happens the spreads on such vulnerable countries widens to a point where the goal of progressing monetary policy across the grouped economies within the Eurozone becomes delayed due to uncertainty surrounding the weaker economy’s ability to maintain financial stability.

See the below for a better understanding:

Chart 7: Italy sovereign risk premium (10y yield vs OIS, in bps)

I will write an in-depth piece looking into the Eurozone economy as the current situation at hand is intriguing to say the least! But for now that’s it.

You made it to the end, thanks for reading until now. Always grateful; and as always

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Until next time,