UK Bonds Post Historic Gain As Rishi Sunak Victory Ends Policy ‘Chaos’
UK bond yields fell by the most since 1993 after Rishi Sunak emerged as the next prime minister amid an economic turmoil.
(Bloomberg) -- UK bonds posted some of their biggest gains on record as investors bet incoming Prime Minister Rishi Sunak will turn the page on weeks of turmoil dogging the nation’s markets and restore credibility to economic policy making.
Short-dated notes led the rally with the two-year yield falling by the most since 1993 after Sunak -- a former chancellor who had issued a warning over Liz Truss’s “fairytale” tax cuts -- emerged as the winner in the race to succeed her. The gains were supercharged as traders pared bets on future rate hikes.
Truss resigned last Thursday following a market meltdown that pushed yields to their highest in years, forced the central bank to step in to stabilize markets and eventually prompted her to backtrack on plans for vast fiscal stimulus. Investors expect Sunak will draw a line under the economic damage.
“For now, it’s relief that ‘total chaos’ is over,” said Marc Ostwald, chief economist and global strategist at ADM Investor Services Int. “His credit with markets comes from having been a steady hand as chancellor and being a polished communicator who is not going to ‘go off piste’ like the Truss government.”
For his part, Sunak was quick to issue a warning on Monday that the UK faces a “profound economic challenge.”
The two-year gilt yield dropped 37 basis points Monday to end at 3.43%. Longer notes also rallied hard, sending the 10-year yield to 3.75%, the lowest since the day former Chancellor Kwasi Kwarteng first announced his so-called mini budget.
“Sunak is clearly the market choice, and there will be relief that we have a safe pair of hands taking over,” said Russel Matthews, senior portfolio manager at BlueBay Asset Management. “This may not last long, but there will be a honeymoon period. The experiment with an extreme neo-liberal economic policy mix is well and truly over.”
Fiscal Rectitude
Attention is already turning to Sunak’s cabinet and whether he’ll retain Chancellor of the Exchequer Jeremy Hunt, who helped calm markets after engineering the reversal of Truss’ policies. Hunt is due to set out the government’s medium-term fiscal plan on Oct. 31, alongside forecasts from the Office of Budget Responsibility. Concern that those could be postponed has been hanging over the market.
Also looming next week is the next Bank of England meeting. While a 75 basis point hike is still fully priced, expectations of a bigger increase have faded now that fiscal rectitude appears to be returning. Policy maker Catherine Mann on Sunday echoed recent comments by colleague Ben Broadbent, saying that “the curve was perhaps too aggressively priced.”
Numerous Headwinds
Still, once the initial optimism has faded, attention is likely to return to the UK’s bleak economic outlook: inflation at a 40-year high, soaring interest rates, depressed consumer sentiment and a potentially severe recession. Net issuance of gilts for the next fiscal year remains vast and borrowing costs are high.
The damage done by Truss’ premiership meanwhile is lingering. According to James Lynch, portfolio manager at Aegon Asset Management, it could take time for some investors to venture back into the gilts market.
“Risk has been cut down quite a lot and it will take time for people to come back and put it back on,” Lynch said. “We need some stability.”
Read more: UK Can’t Shake Pound Negativity After Weeks of Political Chaos
The pound fell 0.4% to $1.1262 as of 5:42 p.m. in London. It’s languishing well below the peaks reached during the first leadership contest over the summer, weighed down by huge economic headwinds ahead. The outlook for the UK’s credit score was revised to negative by Moody’s Investors Service on Friday.
“While the BOE is expected to announce a hefty rate hike on Nov. 3, this may do little to support cable,” Rabobank FX strategist Jane Foley wrote in a note to clients. “The UK’s poor fundamental backdrop suggests that the pound is likely to continue to struggle.”
--With assistance from and .
(Updates with bond moves, analyst quotes.)
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