As the charts climbed higher on their data terminals, bond market investors watching the shift felt increasingly sick.
The impact of that fateful day in September when Trussonomics was launched on an unsuspecting public with the mini-budget was huge, and it got worse second-by-second, as the panic spread. It is a day that will remain etched in the memories of many for years to come.
“Normal people shouldn’t really ever hear about bond markets,” says one investor at a major fund. “If fixed income ends up on the news, that’s a very bad sign indeed. The whole point of something like a UK gilt [government bond] is to be boring, to tick away in the background.”
Installed as chancellor four weeks ago, Jeremy Hunt faces an uphill battle to reassure investors about UK economic policy, and the first test will come with his autumn statement on Thursday.
Regime change alone cannot fix the damage caused by a largely unfunded budget unleashed during a period of global inflation and high national debt levels, investors and analysts believe.
“If you had a choice, you wouldn’t start from here,” says Paul Dales, chief UK economist at consultancy firm Capital Economics. “In the face of a recession, you’d normally see a government spend more, offer a stimulus package. They just can’t do that because of inflation, and the markets are worried about it.”
The pressure is on to show markets that the UK intends to live within its means. For the government, early signals are that this may mean a return to austerity at a level not seen since the aftermath of the global financial crisis in 2008.
Hunt says Britain faces a “tough road” in order to “restore confidence and economic stability”. The country must “balance the books and get debt falling” and there is “no other way”. To an extent, investors agree. The books do, in their view, need to be balanced over time. Some cuts in public spending may be necessary.
Toby Nangle, an independent economic and markets analyst, says: “Narrative is so important. The government is using it to frame a picture of austerity. Bond markets like austerity because it crushes the economy and that’s very disinflationary.
“But what is good for the bond market and what is good for the country and the wider economy only shares a small place on a Venn diagram,” he says.
A portfolio manager at BlackRock, the world’s largest asset manager, who asked to remain anonymous, says that while some cuts would be necessary, the “overall package and long-term plan are more important”.
“A larger share of the tax burden could fall on wealth. This could even improve productivity and would not have a major toll on market confidence if it was sensibly done,” they said.
This does not mean the UK can afford to be complacent about its spending plans, however. Despite being a relatively rich, developed economy, the pound and government bonds have moved more like assets associated with an emerging market in recent weeks.
While the markets may appear calm, the stakes remain high, and investors are on edge.
One trader who requested anonymity says: “Put it this way: I’d stopped smoking before Trussonomics. I had three years without a fag. Now I smoke again.”
Bond market “vigilantes” as they are sometimes termed, thanks to their history of forcing fiscal U-turns around the world, are more concerned that inflation is not fanned by a huge stimulus, and that the budget is funded, rather than advocating austerity for its own sake.
“It is important that it is funded. As long as it is funded the bond market vigilantes are completely fine with it,” says Kaspar Hense, a senior portfolio manager at BlueBay Asset Management, an investment company which focuses on bonds. “If you take the money from the rich and give it to the poor that is completely fine for the bond market. The bond market is not too antagonistic in that sense.”
Dales says a £54bn package of cuts, equivalent to 1.9% of GDP, would be of a similar magnitude to the austerity budget of 2010 overseen by George Osborne.
However, with the UK economy already likely in recession, which the Bank of England expects to be the longest in modern history, investors would probably be content with a greater balance between redistribution of wealth rather than leaning so heavily on cuts.
Poorer people are more likely to spend the money they have than their richer counterparts, who are more likely to save spare funds, which could improve long-term economic prospects.
So long as measures lead to the right kind of growth – one that is productive, increasing output an hour, rather than just feeding inflation – investors in long-dated debt might tolerate more borrowing.
“The other point is around productivity. If there is a believable way that debt levels will be higher but growth levels will increase by even more, then the bond market could also take that as a positive,” says Hense.
“All policy measures now, when we are at high debt levels already, have to be explained carefully and have to be seen as productivity enhancing.”
Increasing immigration amid a tight labour market could be one way to boost growth, increase the tax take and avoid an inflation surge, he suggests. In this way, there could have been parallels for Trussonomics with Reaganomics in the 1980s, when the then US president allowed for a rise in immigration. Some investors say that while the how was not laid out clearly, the idea of embracing higher rates of immigration was something that Truss got right.
“While in the 1980s the US had a huge increase in immigration, the UK, with Brexit, has had the opposite. A huge difference which is negative for growth,” says Hense.
Investors have also warned that improving the UK’s trading relationship with the European Union is critical. By building measures that can ease trade in services, the UK’s economic specialism, it could increase Britain’s growth prospects.
“The worry is that Sunak is a Brexiteer. We’re hoping that he’s a pragmatist first and foremost. The signals of smiles with him and [French president Emmanuel] Macron bode well. But trade in services is critical. Financial professionals are important for the exchequer,” says the portfolio manager at BlackRock.
The UK has a high ratio of debt-to-GDP of more than 100% of GDP according to the Office for National Statistics, a measure that can help indicate how much a country can afford to borrow.
And, unlike other major economies with a large pile of debt such as Japan – an example often favoured by Truss – Britain also has a yawning current account deficit. It stands at a record of 8% of GDP and the UK depends on foreign investors to fund it.
The deficit is the result of Britain importing far more than it exports, leaning heavily on foreign investors’ appetite for UK assets in order to avoid a sharp devaluation of the pound.
The high rate of borrowing and a large current account deficit, often termed a “twin deficit” problem, makes the UK’s borrowing power weaker than other major economies.
But even if no-holds-barred austerity is not the only option to keep markets on side, that will not make it easy for the chancellor.
Decisions about which assets to buy or sell often rest on a risk analysis based on historical data. After recent wild yields on UK government bonds this debt comes with a riskier profile. The government will have to tread carefully for months, if not years, to avoid the prospect of a sell-off.
“You can’t unburn toast,” says Nangle. “It’s more technical than people may realise, but in basic terms, data informs the quantitative strategy that investors take. That data is now in the machine. It’s baked into the maths. It frames future decisions.”
