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The official Perkins Verdict on whether the US has acquired a post-Liberation Day “moron risk premium” — no — came in more than a month ago, but that hasn’t stopped people pointing at Britain in a there-but-for-the-grace-of-God kind of way.
Goldman Sachs has got in on the action today, exploring the “long shadow” of Liz Truss’s ill-fated application of FAFO economics in a country that is heavily reliant on foreigners buying its debt.
Analysts Freidrich Schaper and George Cole write:
Across a variety of measures, such as relative term premium, curve shape, correlations, inflation risk, GBP performance, or sensitivity to fiscal news, the UK Gilt market has remained susceptible to damage from a worsening of inflation and growth performance. This sort of shock raises risk premia and weakens the safe-haven correlations of bonds and raises volatility as it limits the potential for either monetary or fiscal policy to dampen economic shocks.
There are signs that when the going gets bad, people now dump Britain. Part of this dynamic is that gilts — a conventional hedge for UK equities — don’t hedge quite so good no more, with the relationship between long-dated UK bonds and equities now “frequently positive”.
“More importantly,” they write:
that positive correlation has been particularly pronounced on “bad” days, where equity sell-offs have been relatively large, and, since then, occurrence of “EM-like” correlations, where the currency, equities and bonds jointly sell off, have become more frequent, a pattern not seen since the early 1990s
The chart accompanying that is certainly eye-catching (we took a look at “bad day” here, although we can’t really do this dynamic full dataviz justice until we get our hands on a ternary chart):
Another relationship that appears to have broken down post-Truss is between gilt yields and GBP. Normally these two would have moved up or down together — now, not so much. Goldman says this shift is “complicating the investment case for foreign investors and casting doubt on the functioning of the Gilt market”.
The gilt-market dysfunction can also be viewed through distortions in yield curves — comparing yields with fitted values “shows that since the mini-crisis the curve has been significantly less well-behaved, with distortions remaining notably above their long-run average”:
Of course, there’s another late-2022 vertical label line one could place on those charts above: “Liz Truss” could be swapped for “Bank of England starts quantitative tightening”. Goldman’s not having it:
While it is possible that QT has somewhat contributed to this — and judging from the BoE’s decision to postpone a QT auction recently they are seemingly aware of that — the Gilt turmoil has certainly been the main catalyst, and the heightened fiscal sensitivity since has kept the curve highly distorted.
It’s not all relentlessly bad. In recent weeks, Goldman writes, UK assets have behaved a bit more conventionally, something that can be helped (they reckon) by further macro mollification and our old friend fiscal discipline:
This combination of improved incoming macro data and better fiscal credibility should, over time, allow markets to assign a higher probability to a better trade-off between growth and inflation risks. Although, given the legacy of the mini-budget, this journey is likely to be a long one.
Americans, the analysts reckon, can probably escape the worst of this. Which is nice for them, at least.
Further reading
— Putting some perspective on Britain’s bad markets week