A five-minute guide to what is happening in UK equity, bond and currency markets

To say it’s been a momentous week in UK stock, bond, and currency markets, is putting it mildly.

The new Chancellor’s not-so-mini mini-Budget last Friday comprised the biggest tax cuts in 50 years in the hope it would drive enough growth to avoid recession. But worries that it could cause more inflationary pressure and put too much debt on the UK’s balance sheet caused global investors to decide that the plan was flawed. And that’s a problem, because we rely on foreign investors to buy the very bonds that would fund these announcements.

The pound hit a new low against the dollar (bringing it worryingly close to parity and a level not seen since the currency was floated in the modern system in 1971), government bond yields spiked (the 30-year gilt hit 5.17% at one point, the highest it has been since 2002), the FTSE fell below 6,900, and many mortgage lenders took deals off the table as they are unsure how high and how fast interest rates will now have to rise.

Institutions step in

The International Monetary Fund has taken the unusual step of warning that the measures announced in the Budget could have “serious negative consequences” and “increase inequality”, and is recommending against its implementation, saying that due to “elevated inflation pressures”, it did not recommend “large and untargetted fiscal packages at this juncture”.

The Bank of England has also stepped in and is delaying its planned sale of gilts, warning of a “material risk to UK financial stability”, and temporarily purchasing long-dated UK government bonds instead to “restore orderly market conditions”.

Chancellor Kwarteng then felt it necessary to meet with asset managers, pension funds and insurers from firms such as Royal London, BlackRock, Fidelity and JP Morgan, in an attempt to calm market sentiment.

To quote Lenin, there are decades when nothing happens and there are weeks when decades happen. And it’s been one of those weeks.

What can investors do to mitigate the volatility?

Well, let’s start with the good news. The weaker pound is actually good for investors who have overseas or US equity holdings. This is because although global equities have also fallen in recent months, these investors have made a lot on the currency as the pound has weakened.

We mentioned this last week in our article on what a strong US dollar means for UK investors, highlighting the fact that while funds such as Murray International, JOHCM Global Opportunities, Lazard Global Equity Franchise and JP Morgan US Equity Income had all fallen more than 7% in dollar terms, they had posted positive returns of more than 9% when converted to sterling.

The weaker pound is also good news for many large UK multinationals. The likes of Shell, BP or Unilever, for example, benefit from a weaker pound as much of their revenues are in dollars and they aren’t really that affected by the UK economy. This means UK equity funds that invest in larger companies are fairly insulated as well – funds such as City of London, TB Evenlode Income and JOHCM UK Dynamic, for example.

The bad news is that, at least in the short-term, smaller UK companies with domestic exposure are vulnerable. Those with bond holdings are also likely to have suffered steep losses. Unlike equity funds, bond funds typically hedge their currency exposure back to sterling. This means they haven’t benefited from the weakness in the currency. At the same time, the sell-off in UK government bonds has fed through to corporate bonds causing losses.

But there is more good news. Yields are now much higher. This means investors can expect higher income and returns from their bonds in the future. Our house view has been very negative on fixed income for some years. Now the asset class is starting to look investable again for the first time in a long time.

Keep calm and carry on investing

“It’s easy to get scared at times like this, but many assets have already re priced to reflect the new reality,” said James Yardley, senior research analyst at FundCalibre.

“You can still expect good returns from investing in the stock market for the long-term and prices are now at a much better starting point. It’s also possible that inflation falls in the future and that the status quo reasserts itself in the medium term, in which case all asset classes can do well.

“For those more cautious investors, cash or very short-dated government debt is now looking investable again and certainly a good temporary refuge with yields of 4%+ vs the 0% we’ve been used to.”