LDN - Business

Unstable cable

[September 26, 2022] A look at the day ahead in U.S. and global markets from Mike Dolan.

Britain's gamble to spur growth with unfunded tax cuts into an inflation surge has morphed into a bona fide crisis for sterling and UK government bonds, with questions for all governments seeking ever more debt-funded economic supports.

Supercharging an already rampant U.S. dollar around the globe, the sterling/dollar rate - nicknamed 'cable' by traders - went into virtual freefall at one point early on Monday.

Foreign investors ran for the exits after the new government's fiscal plan on Friday threatened to stretch Britain's finances to their limits and finance minister Kwasi Kwarteng promised even further tax cuts at the weekend.

Sterling, which has cratered almost 10% peak-to-trough against the dollar over the space of a week, plummeted almost 5% at one point early on Monday to a record low against the dollar of $1.0327, breaching its prior all-time trough of $1.0520 from 1985. While it clawed back some of those gains as London trading opened, it remains down another 1% from Friday and was down almost 1% against the euro too.

The pound's plunge comes ahead big auctions of both long-term and inflation-linked British government bonds this week and increasing liquidity issues in the gilt markets.

The scale of the pound's losses and fiscal fears has many traders speculating about emergency rate rises by the Bank of England. Rate futures now price in a three-quarters-of-a-point hike to 3% on or before the BoE's next meeting on Nov. 2.

British 10-year gilt yields are above 4% for the first time in 12 years and the gilt yield premium over German bunds is now homing in on two full percentage points for the first time in 31 years - levels not seen since just before the pound was ejected from Europe's pre-euro currency grid system, the exchange rate mechanism, in 1992.

UK 2-year gilt yield moved above 4.5% - up a whopping 150 basis points this month and the highest since 2008, and reflecting mounting recession fears, the UK 2-10 year government bond yield curve is at its most inverted since the banking crash of 2008.

Although relatively muted minor compared to sterling's drop, the euro also slipped against the dollar after Italy's weekend general election looked set to usher in the most right-wing coalition government since World War Two.

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U.S. Dollar banknotes are seen in this illustration picture taken June 14, 2022. REUTERS/Florence Lo/Illustration

Ten-year Italian government bond yields climbed close to 4.5% and are at are at their highest since 2013, in the aftermath of the euro sovereign debt crisis.

But that move reflected the general selloff in bonds and, in stark contrast to UK government bonds, yield premia over German bunds were little changed from Friday as the rightist coalition looked well short of a two-thirds parliamentary coalition that would allow it to change the constitution without a referendum.

Dollar pressures mounted everywhere.

After last week's dramatic intervention to buy yen on the open markets, Japan's Finance Minister Shunichi Suzuki continued to warn that the country would act again to calm what it saw as excessive speculative curreency market moves.

China also acted in a different way on Monday to rein in yuan ongoing slump against the dollar. The People's Bank of China will from Wednesday raise foreign exchange risk reserves for financial institutions when purchasing FX through currency forwards to 20% from the current zero.

With recession looming and inflation and interest rate pressures inceasing, soundings from European business are darkening and Germany's Ifo business survey for September was well below forecasts. Warning of a global downturn ahead, the Organisation for Economic Cooperation and Development said central banks needed to keep fighting inflation and saw U.S. Fed rates as high as 4.75% next year.

As we approach the end of the third quarter, the S&P500 is in the red for the three months and set to record its third consecutive quarterly loss since the aftermath of the Lehman Brothers collapse in 2008.

Key developments that should provide more direction to U.S. markets later on Tuesday:

* U.S. September Dallas Fed manufacturing index; August Chicago Fed activity index

* Atlanta Fed chief Bostic speaks

(By Mike Dolan, Editing by William Maclean, mike.dolan@thomsonreuters.com. Twitter: @reutersMikeD)

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