Sterling falls to historic lows

Markets had already been battered by a week full of hawkish central bank activity, highlighted by the 75bps hike from the Federal Reserve, but the week ended with intense volatility that seemed to be sparked by the release of a budget from the new Truss government in the UK. The government there will eliminate the top rate of income tax and lower the basic rate to 19% from 20% while also cutting stamp duty paid on property and reversing a planned increase in national insurance payments. A plan to raise corporate taxes to 25% in 2023 from 19% has also been scrapped. While the UK’s chancellor of the exchequer Kwasi Kwarteng has said the focus of the government’s financial policies would be growth, markets loudly rejected the tax cuts as the UK’s fiscal position is set to deteriorate as a result. Sterling has been in free fall since the budget was announcing, closing Friday down 3.6% to 1.0859 before briefly falling to as low as a 1.03 level in early trading today, its weakest level since 1971.

PMI numbers for the Eurozone showed a further deterioration in economic conditions in September, according to preliminary readings from S&P Global. The composite PMI for the Eurozone fell to 48.2 from 49.8 a month earlier, firmly landing in the contraction side of the measure with both services and manufacturing worsening last month. At a country-level, the composite PMI for France actually managed to improve to 51.2 in September from 50.4 a month earlier thanks to a much stronger than expected services read at 53. But Germany’s composite number worsened, falling to 45.9 in September, its worst reading since Q2 2020. Both the manufacturing and services number were weaker as high costs, particularly for energy, are deterring economic activity. With the ECB lining up to maintain a hawkish stance at upcoming meetings, the chances of the Eurozone avoiding a recession are looking increasingly slime.

In the UK PMI readings for September were also weak. The services number fell to 49.2 from 50.9 a month earlier, its first reading below the 50 level since February 2021. But manufacturing also came in weak at 48.5 though slightly less bad than the month previously. Like the Eurozone, high inflation and labour shortfalls are weighing on economic activity.

The US PMI measured by S&P Global improved in September but still remains in contraction at 49.3, up from 44.6 a month earlier. Manufacturing held relatively steady at 51.8 but services showed a big improvement, rising to 49.2 up from 43.7 a month earlier. The numbers are not great and will reinforce a sense that the US is also headed for a recession, even if labour markets are still showing some considerable resilience.

Today’s Economic Data and Events

• 12:00 GE IFO Business climate September: forecast 87
• 18:30 US Dallas Fed manf. Activity September: forecast -10

Fixed Income

• Benchmark government bond markets cratered at the end of the week, driven lower by hawkish central banks over all of last week but the unfunded tax cut plans from the UK government look to have been the catalyst for Friday’s collapse. Gilts plummeted with the 2yr yield rising 45bps to 3.893%, the 5yr up more than 50bps to 4.043% and the 10yr yield adding 33bps to 3.82% as markets expect a substantial deterioration in the UK’s fiscal position. European bonds were also pulled weaker with the 10yr bund yield up 6bps on the day to 2.017% while Italian bond yields jumped almost 17bps as a right-wing populist leader is set to be elected as prime minister.
• Treasuries were relatively more well behaved at the end of the week with the 10yr yield actually falling by about 3bps to 3.685% though yields still added almost 24bps last week as a whole.
• Major bond indices closed sharply lower at the end of the week as risk appetite eroded. An index of high-yield bond dropped by 1.2% while emerging market USD-bonds also closed weaker, down 0.7% on the day. In local markets, South African bonds fell sharply with the 10yr yield up 23bps to 11.206% while Indian 10yr yields added 8bps to 7.388%. Central and Eastern European markets also saw some heavy selling as Russia’s partial mobilization of military forces is raising geopolitical tensions even further.

FX

• The dollar surged last week as the Fed continues to ‘out-hawk’ most other major central banks and as any tolerance for risk evaporated. The broad DXY index jumped 3% over the week, including a 1.7% rise on Friday alone. EURUSD fell by 3.3% last week including a 1.5% drop on Friday, settling at 0.9687 while USDJPY added 0.3% over the week as a whole, with upward moves limited by the Japanese ministry of finance intervening to support the yen mid week.
• Sterling was by far and away the worst performing currency last week with a 5% drop over the five days, including a 3.6% drop on Friday alone. GBPUSD settled at 1.0859, its weakest level since the mid-1980s and well below pandemic level lows. The Bank of England hiked by 50bps last week but may be hiking into an even more deteriorating economy, worsening the outlook for cable.  
• Commodity currencies were also hammered at the end of the trading week with USDCAD up 0.8% to 1.3592 at the end of the week while AUDUSD fell 1.8% to 0.6528 and NZDUSD dropped by 1.8% to 0.5745.

Equities

• It was a torrent of losses for equity markets at the end of last week as investors pulled out of any and all risk positions while the outlook for aggressive hiking by central banks firms up. The Dow ended Friday down 1.6% while the S&P 500 gave up 1.7% and the NASDAQ fell by 1.8%. In the UK, the FTSE was lower by nearly 2% while the broader EuroStoxx index dumped by 2.3%.
• Asian markets were also weaker with the Nikkei settling lower by 0.6% and the Hang Seng down 1.2%.

Commodities

• Oil markets crashed at the end of the week in line with broader moves lower in any risk asset. Brent futures fell by 4.8% to USD 86.15/b while WTI dropped by 5.7% to USD 78.74/b. Oil demand will be at risk in a pending global recession though the scale of decline is unlikely to be anywhere similar to what markets endured in 2020. Nevertheless, sentiment is moving sharply more negative at the moment so further downside may be in store for oil in the near term.
• Metals prices were lower in unison at the end of last week with gold prices off by 1.6% on Friday to USD 1,644/troy oz and the rest of the precious metals complex falling by between 4-5%. Industrial metals also fell sharply with aluminium forwards down by 2.9% on the LME at USD 2,165/tonne and copper falling by 3.2% to USD 7,433/tonne.

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