British market defeat fuels contagion fears around the world

British market defeat fuels contagion fears around the world

Written by David Barbuscia, Mark Jones and Dara Ranasinghe

NEW YORK/LONDON (Reuters) – The scale and speed of British asset sales have rattled global markets, raising concerns about contagion as chaos in a major advanced economy adds to anxiety already caused by sharp interest rate hikes from the United States. And in other places.

After the UK’s mini-budget on Friday, which recorded 45 billion pounds ($48 billion) in unfunded tax cuts, the pound fell to record lows while British bond prices slumped. Signs of turmoil emerged on Wednesday before the Bank of England intervened to calm the markets.

Markets were already nervous due to the energy shock that fueled inflation and a strong dollar that created headwinds globally that prompted the Bank of Japan to make a rare intervention in the currency markets only last week.

“It’s like having a sandcastle where the little bits start falling together,” said Olivier Marciot, Head of Investments for Multiple Assets and Wealth Management at Unigestion, referring to Britain’s contribution to global stress. “I think the UK is one of those pieces…it just increases the pain, it increases the stress.”

Chart: Major currencies against the US dollar

Concern about the UK’s New Economic Policy has added to the already increased volatility, with a rout in gold bonds extending even to safe-haven US Treasuries and higher-rated German bonds.

It is clear that global concern is mounting about the fallout from Britain. Atlanta Federal Reserve Chairman Rafael Bostick warned Monday that events in the United Kingdom could lead to greater economic pressures in Europe and the United States, while the International Monetary Fund on Tuesday targeted Britain’s new fiscal plans. US Treasury Secretary Janet Yellen said on Tuesday that the United States is monitoring developments in Britain, the Financial Times reported.

“There are going to be impacts, there are correlations … some market volatility, and then how it affects the global growth picture,” said Paul Malloy, Mayor of Vanguard. “The United States is a broadly insular economy… We are much more insulated from a lot of global pressures, but nevertheless, we are not entirely immune from what is happening in Europe, China and the United Kingdom.”

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PIMCO’s chief investment officer, Dan Evaskin, said that while he believed the UK developments did not present significant systemic risks, they had increased volatility in already volatile markets.

With UK bond yields rising 100 basis points over two days to multi-year highs, German bonds are also down.

The ICE (NYSE: BofA Move Index), a measure of volatility in the US fixed income market, also jumped to its highest level since March 2020.

The wild volatility of the British pound rebounded across the currency markets, where volatility was already surging. According to a large-scale witness German Bank (ETR ๐Ÿ™‚ Currency Volatility Index, Currency volatility on Wednesday hit its highest level since the COVID-19-induced market crash in March 2020, jumping more than 20% from last week’s levels.

The Bank of England’s announcement on Wednesday that it will buy as many long-term government bonds as needed between now and October 14 to stabilize markets has led to some calm.

However, not all investors thought it was the best approach, with Stanley Druckenmiller of the Duquesne family office saying that buying bonds was not appropriate in the inflationary environment.

Closely watched indicators of financial stress are still contained. US dollar borrowing costs in the currency derivatives markets have risen sharply this week but are still well below the levels they recorded after the Russian invasion of Ukraine in February and the market defeat of COVID-19 in March 2020.

US stock market volatility as measured by the “fear index” has also risen in recent days, but remains below its 2022 high.

But the risk of contagion remains against the backdrop of global uncertainty and rising global interest rates.

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“Markets are selling, central banks are very hawkish…and this sense of confusion means the moves tend to be self-feeding,” said Charles Diebel, head of fixed income strategy at Mediolanum Asset Management.

On Wall Street

The stock index hit its lowest closing level in nearly two years on Tuesday, weighed down by nervousness in the United States over interest rate hikes.

Michael Perves, chief executive of Tallbacken Capital Advisors in New York, said some of the stock weakness could be related to the UK because volatility there leads to “risk off”, including the sale of US government bonds.

In times of acute stress such as during the market crash caused by the coronavirus in March 2020, investors are even selling safe-haven assets such as Treasuries to shore up liquidity and offset losses elsewhere in their portfolios.

Britain is the sixth largest economy in the world and about 5% of global currency reserves are denominated in sterling, highlighting the importance of the UK in the global financial system.

With aggressive US interest rate hikes already causing stress in all global markets, for example through a stronger dollar, talk of a global response to quiet markets is also increasing.

โ€œ(To contain inflation, we need a global response, and the global response must be to dampen demand,โ€ said Padrake Garvey, global head of debt and interest rate strategy at ING Americas. On the fiscal side, that, by definition, doesn’t dampen demand.”

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