1 / Market overview

1.1   United Kingdom - outlier or typical example?

Despite everything that happened around the world last month, September was dominated by the United Kingdom. The country was united as rarely before by the death of the Queen, and divided, as has been the case most of the time since Brexit, in day-to-day politics. The most recent rifts did not even require the opposition. The prime minister, Liz Truss, who has been in office since September 6 thanks to the votes of the party base and despite not being the choice of Conservative MPs, took less than a month to turn her inaugural honeymoon period into a disastrous row, helped by her finance minister, Kwasi Kwarteng. Following publication of what was called a "mini" budget, the yields on 10-year UK government bonds (Gilts) shot from 3.5 to over 4.5% in just three trading days and the pound plunged to an all-time low of 1.035 U.S. dollars before the Bank of England (BoE) felt compelled to intervene.

The most controversial part of the budget, reducing the top tax rate from 45% to 40%, has since been scrapped by the Truss/Kwarteng team. The BoE’s “unlimited” (at least according to the announcement) purchase of 30-year Gilts has so far helped reduce the 10-year Gilt yield to a little below 4% and stabilize the pound at close to USD 1.14. But more than the bank’s short-term fix is likely to be necessary to guarantee stability. The mini budget surprised even Conservative politicians by providing broad relief for top earners and enterprises and optimistically expecting 2.5% growth in the medium term thanks to these policies. That the tax cuts were to be funded from increased borrowing unsettled markets. But it was probably the entire environment that contributed to this deficit budget blowing up in Kwarteng's face. The pound had been weak for some time, British inflation has been high for some time and interest rates have been soaring since early August. Add to that a BoE meeting one day before Kwarteng's speech which resulted in an interest rate hike of only 50 basis points when the ECB and Fed had raised by 75 basis points. In addition, the BoE stuck to its plan to run down the bond holdings accumulated through quantitative easing. The plan is to reduce around 10% of the portfolio, around 80 billion pounds.

Since the jump in Gilt yields immediately spread to other European and U.S. government bonds, it is not unreasonable to assume that investors were no longer concerned solely with the British budget but feared the U.K. might exemplify the concerns of all those countries that had enjoyed a loose monetary policy for many years and now have to fight high inflation rates. This threatens further increases in government debt as the so-called cost-of-living crisis is having to be countered in many cases with fiscal aid packages. In other words, since September politicians have had to come to terms with the fact that budget deficits and public debt ratios are once again being scrutinized more closely by the capital markets. The media are talking about the return of the "bond vigilantes". Italy's new government, which is probably not offended by being called right-wing, populist and EU-skeptic, is also feeling the pressure. The risk premium on Italy's government bonds over Bunds shot up to its highest level since early 2020, despite eager ECB purchases. But the fact that central banks are beginning to accompany their rate rises with bond sales rather than purchases is creating a dangerous mix. 

1.2 Bad week, bad month and bad quarter

The month of September ended with a bang, for stocks, bonds and pretty much all currencies that weren't called the U.S. dollar. The third quarter was split into two. The bear market rally enjoyed good momentum until mid-August, but then sentiment tipped and both equities and bonds fell to new lows. The fact that bonds lost as much as equities at the global level, around 7% for the quarter as a whole, is likely to be of little consolation to bondholders. The annus horribilis just won't stop for them: Since the beginning of the year the Bloomberg Global Aggregate Bond Index has lost a fifth of its value. But given the previous low absolute level of yields, the unabated hawkishness of central bankers and the further upward surprises in inflation figures, this can't really come as a surprise.

The Eurozone posted the first double-digit inflation rate in its history - 10.0% consumer price inflation for September - and in the U.S., core inflation just won't go down - in August, it rose from 5.9 to 6.3%. With these numbers, it's understandable that investors are torn between despair and joy when they see bad macro numbers: lamenting the weaker growth but encouraged by the hope that it leads to lower inflation. At the beginning of October, for example, weak purchasing managers' indices for U.S. manufacturing cheered the markets. But there is still little evidence of any downturn in the labor market, either in the U.S. or Europe.

Other notable price movements in September were in German Bunds: 2-year and 10-year Bund yields both jumped above 2%. Inflation-indexed 10-year Bunds briefly ventured into positive territory, so there was something to earn in real terms for the first time since 2014. Other 10-year bonds also broke through big figures: Italian and British bonds jumped at one point to over 4.5%, while U.S. bonds "only" rose to 3.99%, but the 2-year maturities yielded 4.3%. The dollar also went through the roof, with the dollar index gaining almost 10% within the third quarter. Last but not least, corporate bond yields also leaped in September. High yield bonds are living up to their name and currently yield almost 10% in the U.S. and over 8.5% in Europe. And that might not be the peak yet, given just how nervous investors are.