Market Thinking

making sense of the narrative

Dealing with the Triple Threat(s)

UK households face the triple threat to their finances of higher energy prices, higher interest rates and higher taxes. Meanwhile, the new UK government trying to deal with this face a different triple threat of the markets, their political opponents (in all parties) and the entire globalist Media, academic, political and Mandarin class. Of these, they should actually worry least about the markets – they were primed to sell whatever happened as we discussed here – and not even that much about their political opponents, who will never approve of their policies. However, what is key for investors is that, in order to save the UK private sector, the Truss government have to take on the third group – the globalists and their ‘experts’ who have driven the UK economy into the mess it currently finds itself in through their top-down imposition of a triple whammy of zero carbon, zero covid and zero interest rates.

Truss and Kwarteng want to cut tax and cut spending, and unlike their European counterparts have the policy and exchange rate flexibility to do so. For years their policy opponents have wanted only to cut ‘carbon’ and cut interest rates. This is where the battleground now lies, as well as the opportunity

The Prescription was pre-scripted

The markets‘ reaction to the UK Mini-Budget was already pre-scripted; whatever they said, the CTA traders were going to push their large existing short positions on Sterling and UK gilts, using the Budget as a ‘catalyst’. However, these positions were not related to the UK in particular, the traders have been short almost every government debt market and almost every currency against the $ for many months. Indeed, for all the lurid headlines about ‘fat cat traders’, going short Sterling the day of the Budget would have been a losing position by now. As we discussed in $ to everyone, it’s not you, it’s me, we should not kid ourselves that ‘the markets’ care about the UK in particular.

The notion that the Government are constrained by the markets is highly dubious. They have bigger fish to fry.

The timing of the Mini-Budget was driven by the need to get the policy discussions out ahead of the Tory Party Conference, which necessarily/unfortunately also meant providing helpful headlines for the Labour Party Conference a week earlier. Thus, the political reaction to the Budget was also pre-scripted; once again, whatever the Conservatives had said, the opposition Labour Party was set to claim that the Tories were being reckless and favouring the rich. The initial market reaction just allowed the Labour Party to claim that ‘the markets’ agreed with them, when actually they did no such thing.

Third, the fact that the Truss team had made it clear that they intended some radical reform meant that the Metropolitan, Media, Academic, Political and Mandarin class response was also pre-scripted; again, whatever the Tories said, this, largely unelected, bien-pensant, globalist, dirigiste commentariat were always going to dismiss as being ‘stupid, just like Brexit’, because, far from being a surprise, the small(er) state approach was outlined in Brittania Unchained, a book they co-authored several years ago. A different form of pre-scripted. Plus of course, her leadership campaign pledged to do exactly this, so the claims that ‘markets are shellshocked’ should be dismissed for the politicised rhetoric that they are.

to save the private sector, the government needs to face down the Blob

So far the biggest similarity between Liz Truss and Margaret Thatcher is that the entire economic establishment protested about her first Budget as well…

Ahead of the Budget, a great number of the complaints in the media were linked to the recent sacking of Treasury Chief Sir Tom Scholar, highlighting his brilliance and claiming that it reduces impartiality, (the Treasury are of course highly accomplished at ‘briefing’ journalists as to the brilliance of the Treasury). However, as a quick glance at his CV shows, a working relationship looked highly unlikely as he represented the ‘continuity Brown’ thread that has run through British Policy for over a decade, regardless of who has notionally been Chancellor. The fact that thus far the Tories don’t appear to have touched almost any of Brown’s policies is almost certainly in no small measure down to the influence of Tom Scholar. It is this that they are trying to change, and, as with the Leave/Remain debate, the Metropolitan, Media, academic and Mandarin class, who all benefit from the status quo, are pushing back hard.

It was Tom Scholar’s old boss Gordon Brown of course who brought in the cynical increase to 45p tax two months before the end of his term, leaving it as a deliberate political landmine that no Tory government has so far dared to touch, even now with the forced U Turn this week. Worth noting also is that the media attacks are clearly now being led by the Machiavellian Michael Gove, who has a personal grievance with Liz Truss, not dissimilar to the one Michael Hesseltine had with Margaret Thatcher – as well as being heavily associated with all the (bad) policies she is now trying to counter/undo – especially the consequences of his pet projects of zero covid and zero carbon. Ironically it was when he was at Education that Gove himself coined the term ‘The Blob’ to describe the very same Metropolitan, Media, academic and Mandarin class that has now apparently assimilated him.

Moving fast and breaking things

The reality is that Liz Truss inherited an economy where the UK household sector and small businesses faces an immediate triple threat to their discretionary cash flows – already hammered by the Zero Covid policies of their predecessors;

1) an energy crisis, largely precipitated by the zero Carbon policies, threatening bankruptcy levels of energy costs,

2) a sharp rise in mortgage interest payments as the BoE raise rates in lockstep with the Fed, ignoring the much higher interest rate sensitivity in the UK and

3) a rise in corporation tax and National Insurance already announced by the previous Chancellor and leadership rival Rishi Sunak under the heavy influence of the Treasury.

In their first few days, everything the new team have announced is in line with fixing the mess they have inherited. The fact that the architects of the mess are protesting should in that sense probably be taken as encouraging and somewhat reminiscent of the 364 economists who wrote to Margaret Thatcher in 1981.

Dealing with the Triple Theat

Bringing in emergency support for energy bills on day 1 was essential as otherwise ‘the crazy mechanism’ of energy caps and marginal cost pricing would have wreaked havoc. Reforming it is also key – as the French are also demanding. They can’t do much about interest rates, but not raising taxes (and also unwinding the job destroying self employment legislation) was also essential. Actually cutting rates was good signalling and only a small amount of the total ‘cost’.

It’s not that the tax cuts are unfunded, it’s that the rest of the spending is.

Having put (large) sticking plasters over the immediate threats to household incomes in the form of an emergency energy policy and cancelling the Treasury’s tax increases, the new team need to continue the policy of ‘moving fast and breaking things’ and that includes the stranglehold on policy of the Green Leap Forward lobby, whose influence should not be under-estimated. More nuclear, fracking and a reform of the energy payments system are all on the cards offering opportunities as well as threats to existing ‘winners’. Raising interest rates to ‘neutral’ – probably not far from here – is both necessary and a welcome unwind of the previous, highly damaging, zero interest rate policy, but the BoE needs to step away from their ‘models’ of inflation and take explicit account of the cash flow implications of higher rates.

They should also address the inflationary implications of not defending sterling – as many noise traders are either calling for or highlighting as a macro economic risk. Sure, the UK imports a lot of commodities in $s (including too much energy given it has its own), but they are largely inputs – a relatively small part of the total price. Most obviously, in the case of petrol, fuel duty of 58p a litre plus 20% VAT (on the total price including the Fuel Duty) together make up between 55 and 70% of the price of a litre of petrol. This ‘tax wedge’ significantly dilutes the impact on RPI of any exchange rate weakness. By contrast, a lot of exports are value added goods, where the benefit of a more competitive exchange rate can be substantial. This is not the same as saying they should encourage a ‘run on the pound’, rather that it is more important to have an independent monetary policy, instead of merely following the Fed.

The reality is that the Globalist Consensus that has dominated for over a decade – ultra loose monetary policy, combined with high levels of tax and spend – has broken. Interest rates are being forced higher and the impact on economies is going to be varied (see Central Bankers need to talk to Equity analysts about balance sheets). This requires bespoke fiscal policies, recognising that tighter fiscal policy at the time of tighter monetary policy is a high risk strategy in the real world – if not in the ‘models of the experts’. It also requires a realism about the cost benefit analysis of the other top down policies that have been adopted across the west – most notably those associated with imposing ultra high energy costs under the Green Leap Forward.

The UK has an advantage over Continental Europe that, not only can it be energy independent (if it chooses), but it can have independent monetary policy and flexibility on its exchange rate as it imposes much needed structural reform. If, and when, sterling is seen to be stable, there is a huge amount of $ cash looking to diversify, much as it did last time the $ was ‘king’ and the pound was predicted to go through parity, back in 1985. Then we had big bang and the pound doubling in value, long term investors holding $ cash might consider looking at quality assets in the UK before ‘the markets’ flip and are declared to be in support of the Truss team and their policies.

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