Mazars’ George Lagarias comments on market volatility following Liz Truss’ resignation

by | Oct 25, 2022

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George Lagarias

George Lagarias, Chief Economist at Mazars comments: “The market volatility following the budget and Ms Truss’s historic resignation should not be misinterpreted in the parochial context of the Conservative Party convulsions. Volatility is underpinned by severe bond market dislocations and the return of ‘Bond Vigilantes’. We should thus look at the bigger picture:  Can Brexit Britain deliver on its promises to both the electorate and its key economic stakeholders in a financially illiquid environment? Or is a wider course correction required to restore growth? Ultimately, it does not matter who the Prime Minister of the United Kingdom is. They will be faced with the same question Liz Truss failed to answer effectively: a tough budget or a tough market that may lead to an economic and financial crisis? While the resolution seems plain and painful, we believe the road to an economic rebound lies far beyond 10 (or 11) Downing Street. British economic woes, which have wrought unprecedented political instability are the direct result of quickly worsening global bond market, itself a consequence of rapid US rate tightening and China’s economic slowdown. Yet both these conditions are the result of two specific decisions: The Fed’s focus on inflation fighting, and China’s zero-Covid policy. As such, the problems are reversible. Thus, those worrying about their investments, their pensions, economic growth, inflation and economic stability, the answer will be come from the US Federal Reserve and China.”

“For one, we are quickly approaching the point where stabilising the bond market will become more important for the Fed than fighting inflation. Something along the lines of “we acknowledge the build-up of external risks” could be enough to signal an eventual pivot to more accommodative policy and prompt a risk asset rally. Meanwhile, China’s economic path can improve markedly if the country abandons zero-Covid. A total shift of that policy would probably be received very well by markets. A third venue which could affect British finances, is of course the Kremlin. But the war in Ukraine seems set to persist at least throughout the winter. However, the first two conditions for markets to stabilise, could be met within the next few months.”

History, recorded or oral, lies. Often and a lot. Its aim isn’t to teach. History’s role isn’t to describe, but rather to ascribe and thereafter prescribe. It is to simplify, to tell a story that will form the basis for national identities. No two histories are alike. The defender will tell a story of the wrongs inflicted on them and the aggressor will tell another, of how they were left with no alternative to defend themselves. Winners get to write the approved version.

The lie that is most often told is that of iconic leaders, who won simply because of the merits of their personalities. Henry V won in Agincourt because he was smarter than the French. So did Elizabeth I when the Spanish Armada invaded. All of them brave and unique, to be sure. But also lucky. It was long bows and desperation but also some wrong decisions by the French that turned wayward Hal into the Pride of England. And a simple gust of wind blowing the other way could have seen the Spanish land in Plymouth.  

Winston Churchill is credited as the iconic PM who kept Britain together, repelled the German invasion and set the stage for World War II to turn around. Today, the realm worships his personality and swears that his like will never be seen again. The hero defeating the beast makes for a great story. However, what history often fails to mention is how often things could have gone the other way.

What if the Germans had destroyed the British army in Dunkirk, instead of mysteriously waiting? What if the Luftwaffe hadn’t given up a week early in the Battle of England? What if Air Marshall Hugh Dowding, detested by Churchill, had been replaced before the battle, instead of (ignominiously) after it? What if Edward VIII, who urged for peace between Britain and Germany even after London was bombed, hadn’t abdicated the throne two years before the Second Great War?

So many ‘ifs’, so many possible histories that had nothing to do with Churchill’s personality.

Which brings us to the question at hand. At this strange political juncture, the UK is beset on all sides by danger. The economy is slowing precipitously. Consumption is waning, and bordering a demand shock, especially after Mr Hunt’s dire warnings for painful spending cuts. The jobs market is suffering from a skills shortage, and supply chains are thin, all direct results of Brexit. The UK bond market nearly imploded two weeks ago, and it is still in a very precarious position. Meanwhile, interest rates and mortgage prices keep going up to fight supply-side international inflation, a battle that has always been difficult to win.

Facing these challenges, the Conservatives, who have ruled for more than twelve years, are convulsing. Who will pick up the sword? Who is worthy of it? But history isn’t written just by personalities. It is a tide, where some individual decisions make a difference to be certain, but outcomes are equally affected by the prevailing winds.

At the time of writing Rishi Sunak is the bookies’ favourite. Penny Mordaunt an outsider. The whole world has been transfixed in a British drama that, quite frankly, makes Season 5 of ‘The Crown’ look cheap soap opera.

Nevertheless, the market volatility following the budget and Ms Truss’s historic resignation should not be misinterpreted in the parochial context of the Conservative Party convulsions. Volatility is underpinned by severe bond market dislocations and the return of ‘Bond Vigilantes’. We should thus look at the bigger picture, and the larger question:  Can Brexit Britain deliver on its promises to both the electorate and its key economic stakeholders in a financially illiquid environment? Or is a wider course correction required to restore growth? 

Which brings us to the real question: As an asset manager, what should we tell clients, other than to ‘wait’? What should they be ‘waiting for’? Ultimately, it does not matter who the Prime Minister of the United Kingdom is. They will be faced with the same question Liz Truss failed to answer: a tough budget or a tough market that may lead to an economic and financial crisis? While the resolution seems plain and painful, we believe the road to an economic rebound lies far beyond 10 (or 11) Downing Street. 

The answer for all portfolios, local or international, focused or diversified, is the same: Do not look for a solution in British politics. It could take a long time before the UK sees a stable government. Mr Sunak’s challenges in November are far different than what they would have been. Instead, for those worrying about their investments, their pensions, economic growth, inflation and economic stability, the answer will be come from 1850 K Street, in Washington, DC and Zhongnanhai. The former is the address of the US Federal Reserve. The latter, a 16th century Chinese imperial garden, is Xi Jinping’s seat of power. British economic woes, which have wrought unprecedented political instability are the direct result of quickly worsening global bond market, itself a consequence of rapid US rate tightening and China’s economic slowdown.

Yet both these conditions are the result of two specific decisions: The Fed’s focus on inflation fighting, and China’s zero-Covid policy. As such, the problems are reversible.

For one, we are quickly approaching the point where stabilising the bond market will become more important for the Fed than fighting inflation. The timing augurs well. After November, Year-on-Year inflation could begin to subside, due to base effects. The US Mid-terms will be over, so the politically-minded Fed members, many more than in the past, may not worry about the political backlash of their decisions. Also, the Federal Open Market Committee’s (FOMC) composition will change in January, to include less hawkish voting members.

Bond market volatility has already claimed its first big victim, a G7 government. Markets, which usually are bullish in the last two months of the year, are waiting for a simple signal from the Fed. Something along the lines of “we acknowledge the build-up of external risks” could be enough to signal an eventual pivot to more accommodative policy and prompt a risk asset rally.

Meanwhile, China’s economic path can improve markedly if the country abandons zero-Covid. The Plenum is over, and Xi Jinping was confirmed for a historic third term. Already the country has announced the lifting of some restrictions for inbound travellers. A total shift of that policy would probably be received very well by markets.

A third venue which could affect British finances, is of course the Kremlin. But the war in Ukraine seems set to persist at least throughout the winter.

However, the first two conditions for markets to stabilise, could be met within the next few months. No one can promise it, time it or forecast it, of course. Assuming that what we think logical is the course that will ultimately be decided by the policymakers may be false. However, we believe that ultimately, the powers that be will act in theirs, and everyone’s best interests.

As citizens, Downing Street drama is impactful and important. As investors, however, and taxpayers, people should rather be mindful of developments in Washington, Beijing and possibly Moscow.

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