I happened to be in London when the British pound was destroyed by the USD. On Friday, September 23, the GBP lost 3.6% of its value and then dropped to an all-time low of $1.04 early Monday morning in London. It recovered enough the following day to trade around $1.08, still a 37-year low. By comparison, the pound was at $1.35 at the beginning of the year.
That was definitely a "can you believe the currency of one of the world’s superpowers will drop like it’s TQQQ in a day" kind of moment!
The United Kingdom is living in incredibly difficult times. The British pound has experienced some of its worst days on record and that has impacted their gilts. Bond markets have had a terrible year everywhere, but the fall in the UK’s debt this year, at 27%, has been one of the worst. Speculators are betting that there's more dreadful news to come, with option markets implying there is a 43% chance that the pound will hit parity with the dollar before the end of the year. British hedge fund manager Crispin Odey agrees that the pound is not out of danger, saying in an interview, "I think sterling is still quite vulnerable and we have to see how it goes."
While some supporters of the British government’s strategy have pointed to the USD’s run this year as the cause of sterling’s slide, the pound also fell against the euro.
The euro is currently trading around £0.89 — up from £0.84 at the start of the year — despite the euro zone facing its own significant challenges, ranging from an energy crisis to growing recession risks.
Gilt yields are now set for their biggest monthly rise since at least 1957, based on a Reuters analysis of both Refinitiv and Bank of England data. The yield on 10-year gilts, which influences mortgages and other borrowing rates, has climbed from 2.882% to 4.073% so far in September.
Soaring yields and a slumping pound have led some mortgage lenders to pause new home loans and withdraw certain mortgage offers.
Fuel was added to an already-blazing fire when British Chancellor of the Exchequer Kwasi Kwarteng tabled an oddly-named “mini-budget” that included tax cuts expected to total £45 billion in the coming years, along with a massive spending increase to help households and businesses deal with higher energy bills. These higher debt levels left investors feeling more than a little uneasy about the UK’s future, especially in light of Kwarteng’s target of a 2.5% growth trend and his promise to release a plan to reduce debt as a percentage of GDP in the medium term.
Kwarteng’s announcement that the United Kingdom would implement the biggest tax cuts in 50 years while increasing government borrowing and spending during a time of high inflation raised questions from various sources.
“Serious questions are already being asked about the economic competency of the new government,” Craig Erlam, senior market analyst at Oanda, has said. “So much so that markets are factoring in a strong chance of a substantial emergency rate hike from the Bank of England in order to shore up the currency and confidence in the markets.”
The new tax-slashing fiscal measures, which include scrapping plans for an increase in corporation tax and slashing top income tax rates, have been criticized as “trickle-down economics” by the opposition Labour Party and even condemned by members of the Kwarteng’s own Conservative party.
Kwarteng, however, held tight to his position, hinting in interviews that there might be more tax cuts to come, and saying Friday’s measures were “just the start” as the government went all out for growth. Former Tory chancellor Lord Ken Clarke criticized the tax cuts on Sunday, saying they could lead to the collapse of the pound.
“I’m afraid that’s the kind of thing that’s usually tried in Latin American countries without success,” Clarke said in an interview with BBC radio.
Inflation sits at 9.9% and the UK is showing many signs of already having entered a recession. The coming year is likely to be especially difficult.. Recently-appointed Prime Minister Liz Truss’s £100 billion ($115 billion) plan, to help the economy through the economic crisis is not convincing investors who are very aware that higher government spending tends result in higher inflation. With Russia’s war in Ukraine contributing to further increases in food and fuel prices, inflation is expected to go even higher this winter. The massive government spending package, is likely to drive prices even higher – possibly as high as 22% next year, according to Investment bank Goldman Sachs.
There is considerable consensus among economists now that the United Kingdom is on the path to stagflation, a discouraging and prolonged period of slow or negative growth accompanied by high inflation. In August, the UK’s government 10-year bonds saw their largest rise in yields since the late 1980s. And the British pound fell sharply too – dropping 4.5% against the USD, the worst performance among the big “G10” industrialized economy currencies.
A key question now is whether the Bank of England, which has already boosted interest rates from 0.1% to 2.25% over the last nine months, will be pushed into faster and higher rate rises.
Governor Andrew Bailey has stated that the bank would “not hesitate to change interest rates as necessary.” However, he said a decision would be made at its next scheduled meeting in November, dampening speculation of an emergency rate hike or intervention to prop up the pound.
The UK overnight indexed swap market, however, has raised the possibility of an 80% chance of a hike to 3.5% by November 3 ( a 125 basis points rise) and a 20% chance of an even higher hike to 3.75%.
UK stocks pared some of their sharp losses on Wednesday after the Bank of England said it would start a temporary programme of bond purchases to stabilise the market.
More recently, the Bank of England announced on Wednesday, September 28th that it would buy as many long-dated government bonds as needed between then and October 14th in an effort to stabilize financial markets.
Expressing concerns about potential risks to UK financial stability, the BoE also said it would delay the start of a programme to sell down its 838 billion pounds ($891 billion) of government bond holdings, which had been scheduled to begin the following week.
The BoE added that it remained committed to an 80-billion pound reduction over the next 12 months in holdings of bonds bought under its quantitative easing programme following the global financial crisis and during the COVID-19 pandemic.
British 30-year bond yields had reached their highest since 2002 that same morning, before the BoE announcement, and traders complained it was becoming increasingly hard to buy and sell bonds as no one wanted the risk of holding such a volatile asset. That announcement came amid rumors that some UK pension funds were quickly becoming insolvent as a result of huge margin calls they couldn’t meet.
The BoE said it had no choice but to intervene. The Treasury said it would indemnify the operations.
"Were dysfunction in this market to continue or worsen, there would be a material risk to UK. financial stability," the BoE said. "This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy."
The central bank reportedly placed no fixed limit on the scale of its intervention.
Although there is no doubt that the pound has been pummelled by the United Kingdom’s own economic strategies, another key factor has been the dramatic rise of the US dollar, a safe haven that traditionally attracts investment inflows during uncertain times.
The euro itself hit a 20-year low after Giorgia Meloni scored a decisive victory in Italy’s general election. Investors are keeping a close eye on what could turn out to be the most far-right government since the fascist era of Benito Mussolini.
The pound, however, is suffering more than most due to the economic outlook in the United Kingdom, which faces the highest inflation among G7 nations, and the government’s huge fiscal gamble on growth. It has lost nearly 21% so far this year, compared with a fall of 15% in the euro.
The previous record low for the British pound against the US dollar was 37 years ago on February 25, 1985, when one pound was worth a little over $1.05.
“Should there be any escalation to the war in Ukraine … we would see further sharp downside in the pound as well as the euro,” said Clifford Bennett, chief economist at ACY Securities, an Australian brokerage firm has said.
“One should not underestimate the crisis that is all of Europe at the moment and the pound is more vulnerable than most,” he said.
The soaring US Dollar also caused major Asian currencies to drop on Monday. September 26.
China’s yuan slid 0.5% on the onshore market to the lowest level in more than 28 months. The offshore yuan fell 0.4%. The rapid declines prompted the People’s Bank of China to impose a risk reserve requirement of 20% on banks’ foreign exchange forward sales to clients, starting Wednesday. That should make it more costly to buy foreign currencies via derivatives, which might slow the pace of the yuan’s decline.
Elsewhere in Asia, the Japanese yen dropped 0.6% against the dollar to 144. Last Thursday, the Japanese central bank intervened in the currency market for the first time since 1998 to prop up the yen when it hit 145. The yen rebounded slightly following the intervention, but soon resumed the slide. Stock markets in Asia were also in turmoil on Monday, after US stocks were sold off as fears of a recession grew.
South Korea’s Kospi declined 2.7%, Japan’s Nikkei 225 (N225) dropped 2.4%, and Australia’s S&P/ASX 200 was down 1.4%.
In Europe, London’s FTSE 100 (UKX) was the weakest index, but Germany’s DAX (DAX) and France’s CAC also slipped lower. Italian stocks got a lift after slumping last week ahead of the elections.
The world is falling apart, as everyone who follows the market knows. The US Federal Reserve is collapsing the stock market and, more importantly, the bond markets. This will trigger a major economic recession, starting with the housing market and moving onward. Goldman Sachs and BlackRock are warning that the markets are not pricing in the risk of a global recession yet, and most likely SPY and QQQ will experience more significant drops in the short term. Ned Davis Research now sees a 98% chance of a looming global recession. A former Chinese central bank official warned that the Federal Reserve’s most aggressive interest rate hike cycle since the 1980s is destabilizing global financial markets and harming other economies.
Maybe it is time for Americans to buy everything that they can in Europe (including in the UK). Given the cheap dollar, some of my investor friends are considering buying tons of property in Spain, Portugal, and possibly the UK.