Truss Faces Market Judgment as BOE Exit Leaves UK Exposed

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UK financial markets will get a fresh opportunity to pass judgment on Prime Minister Liz Truss’s economic program on Monday without the Bank of England around to offset any turmoil.

Rarely has a developed economy’s political fortune been so caught up in market gyrations. Traders’ brutal rejection of the premier’s fiscal plan have already sent the pound to record lows and forced Truss to sack Chancellor Kwasi Kwarteng, leading to the rollback of some of her marquee tax cuts. Questions about what would it take to bring back investor confidence and Truss’ own future are also swirling.

BOE Governor Andrew Bailey said he has already spoken to the UK’s new chancellor of the exchequer, Jeremy Hunt, and they agreed on the importance of fiscal sustainability. That’s after an unconvincing appearance by Truss on Friday, where the premier acknowledged the extraordinary bind she was in, saying “we need to act now to reassure the markets of our fiscal discipline.”

The latest interjection by officials may help calm nerves. Still, even previously unthinkable moves by her government have not proved enough to get investors back on side, and, with the BOE’s emergency bond-buying program now expired, UK markets are set up for another febrile start to the week.

“Clearly confidence has been hurt by what has happened over the last three weeks, and that may take some time to build,” Rohan Khanna, rates strategist at UBS AG said on Sunday.

Read more: Goldman Downgrades UK Growth Outlook After Government Tax U-Turn

The pound rose 0.5% to $1.1226 in early Asia trading, after closing around 1.4% lower on Friday. For investors, the gilt market open on Monday will be key.

While the fiscal backdrop now looks more supportive with Hunt as chancellor, there is still uncertainty over whether liability-driven investment funds, the strategies used by pension funds that exacerbated the gilt-market selloff, have had time to rebuild cash buffers before the BOE’s backstop ended.

“Clearly the message coming from the government should be a source of support for the market, but it’s really difficult to say how much of the cleanup from the LDI community is still pending,” Khanna said.

Read more: Hunt Wins Backing of Bailey’s BOE, Leaving Truss Sidelined in UK

UK gilts will resume trading at 8 a.m. Monday morning in London. Another spike in yields could force more moves from Downing Street, or even a fresh support plan from the BOE. Bond auctions on Tuesday and Wednesday will also be ones to watch.

Friday afternoon gave a troubling foretaste of what may be to come. While gilts had enjoyed a strong rally as rumors of a u-turn swirled, they tanked after Truss delivered an underwhelming press conference that was short on details of how she plans to fill the UK’s fiscal black hole.

The dramatic selloff on Friday sent the yield on 30-year gilts to 4.78% at the close, approaching the 5% level which some see as a line in the sand for BOE intervention. The securities swung almost 60 basis points in a matter of hours, resembling the stunning moves which forced the BOE into the market last month.

Read more: The Nonstop, Crazy Week of UK Markets, as Told in Charts

“The market was not enthused by the remarkably brief press conference,” Richard McGuire, strategist at Rabobank in London. “A U-turn is unlikely to restore credibility when it is forced, while throwing one’s partner in crime under the bus is unlikely to either, given the policy proposals were clearly a joint effort.”

No Support

“The outlook for both the politics and the market remains uncertain and the situation continues to move fast,” wrote Daniela Russell, a rates strategist at HSBC Holdings in a note to clients. “The immediate question for gilt investors is still: how will the market navigate the end of the backstop?”

The BOE’s emergency bond buying — announced at the heart of the market turmoil that followed the government’s botched fiscal plan — came to an end on Friday with the bank having snapped up almost £20 billion of bonds. While that’s a fraction of their £100 billion warchest, it brought a modicum of calm to turbulent markets that now have to go it alone.

They are still hopes the BOE may do more, with some calling for the Governor to channel former European Central Bank President Mario Draghi’s pledge to save the euro.

“If the market is really collapsing again, I don’t see any option but for the BOE to step up again,” said Marc Kersten, portfolio manager at Union Investment, Frankfurt. “This could be a kind of whatever it takes moment for Bailey.”

In a speech in Washington on Saturday confirming the end of purchases, Bailey said the BOE wasn’t trying to steer bond yields. “We will not hesitate to raise interest rates to meet the inflation target,” he said. “As things stand today, my best guess is that inflationary pressures will require a stronger response than we perhaps thought in August.”

(Updates pound pricing at the start of session in Asia in)