Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist
Wednesday, October 26, 2022
British bond markets and the British pound received a boost on Tuesday as Rishi Sunak, a former chancellor of the Exchequer and Chief Secretary to the Treasury, was named the new Prime Minister (PM) of the United Kingdom (UK). Mr Sunak is expected to provide more financial stability to the volatile UK economy than it has experienced so far in 2022.
It was 1964 when former PM Harold Wilson was said to have mentioned that “A week is a long time in politics” but never has this been truer than the last few weeks in the UK. It has been a tumultuous time for UK politics with three different PMs being in power during the past seven weeks alone (for comparison there were only three PMs within 28 years from the Margaret Thatcher to Tony Blair eras).
The unfortunate chain of events kicked off when Boris Johnson resigned as PM in July, following the “partygate” scandals in which Mr. Johnson appeared to break COVID lockdown rules for social get-togethers, including his birthday, with government staff. He eventually left office in September when Liz Truss was named his successor following a vote of conservative party grassroots members. This was where it all started to unravel for the UK as Ms.Truss and her chancellor, Kwasi Kwarteng, unveiled a largely unfunded round of tax cuts, labelled locally as “Trussomics”.
Markets panicked as the government appeared to be stoking inflating just as the Bank of England (BoE) was trying to stem it, causing the sterling to briefly fall to its lowest ever level against the US dollar and for UK government borrowing costs to soar. This, in turn, caused huge losses for UK pension funds that were heavily exposed to gilt (UK government debt) yield fluctuations, forcing the BoE to step in with billions of pounds of gilt purchases to shore up the market.
Mr. Kwarteng resigned initially but it wasn’t enough for the House of Commons (the UK equivalent of the Senate/House of Representatives) and Ms. Truss soon followed, resigning after only 44 days in office – becoming the shortest ever serving PM in UK history.
There had been speculation that former Prime Minister Boris Johnson was going to run again for PM but he withdrew from the race over the weekend as it became clear that Sunak had significant internal support from the Conservative party. As shown in the LPL Chart of the Day, the 10-year British gilt yield declined as the appointment of Rishi Sunak as the new UK Prime Minister was received positively by the market.
Mr. Sunak has a tough job ahead of him. Even aside from the ill-fated “Trussonomics” mini-budget, the British pound had been weakening for some time amid a backdrop of dollar strength and a poor outlook for the UK economy wracked by rising energy costs and a cost-of-living crisis. LPL Research’s Strategic and Tactical Asset Allocation Committee maintains a overall negative view on developed international equity markets, including the UK, given the energy and currency headwinds that are hampering the post COVID-19 recoveries of most European economies.
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