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For stock market geeks like me, yesterday will likely go down in history as a memorable moment in the UK, akin to that of a 2008 crash moment - one which people will be talking about for decades to come.

What happened? It has all spun off Kwasi Kwarteng’s “Mini Budget” which has proven akin to a fiscal hand grenade thrown into the UK bond market. UK Government bonds, under the triple threat of a massive increase in UK bond issuance to fund the energy price cap, further interest rate rises and quantitative tightening (that’s the Bank of England selling back all of the bonds they have been buying off the government for the past 13 years (started around 2009,) the UK Government debt market has tanked quite spectacularly (hence the hand grenade reference). To put the selloff in perspective, in the history of the UK Government bond market, the largest single sell off was -9%. September’s sell off, as of Wednesday morning, from the highest point to the lowest, was down a touch over -30%. To call that a new record doesn’t quite do the situation justice and it’s chiefly why I have chosen to write a note explaining what’s going on.

As almost everyone knows, the backbone of the UK’s behemoth pension industry is UK government bonds and on Wednesday morning it looked like there were some very large pensions funds about to tip into insolvency from the losses being inflicted on portfolios. This is what prompted the BoE to intervene.

Shortly after the market opened on Wednesday the Bank of England got wind of the potential implosion in UK pensions and stepped in swiftly to prop up the market and essentially save a large number of UK pension savers. This came in the form of the central bank halting quantitative tightening (selling the bonds they have been buying for the last 13 years) and recommitting to buying £65 billion worth of UK government bonds at £5 billion a day for 13 days. Essentially the BoE turned from quantitative tightening into quantitative easing in a matter of minutes to save the UK pension industry. This had the desired effect. The mainstream UK bond market bounced up over 7% with long maturity bonds rallying over 18%. The positivity spread over into the US with government debt rallying over 1% and US stocks also rallying nearly 2% on the news. Great for investor portfolios.

So how exposed were TAM’s clients to this blockbuster volatility? TAM is a UK investor by nature and as such we have a natural exposure to the UK bond market but TAM clients remain nowhere near the fear which gripped the UK pension industry. It’s worth reminding our clients that TAM is a cautious investor by nature which steps away from volatile markets. Befitting this approach, TAM’s exposure in 2022 to UK bonds has been cut to some of the lowest levels we have ever owned - which is both a boon to our performance and a boon to protecting client portfolios during this volatility saga in which TAM was more of a spectator than a participant. TAM’s exposure to UK government debt resides almost exclusively in longer maturity bonds the likes of which the BoE started buying yesterday and as a result our clients were able to enjoy being invested into that 18% rally we saw yesterday.

The intervention we saw yesterday was welcome but doesn’t change our thinking when it comes to UK bonds and the UK economy. Economically it doesn’t make sense to be pumping money into the bond market at the same time as you are fighting inflation. They are opposing forces which will further clobber the pound and create unwelcome volatility - which will then need more aggressive interest rate hikes to tame. It’s a scenario which is simultaneously destroying the credibility of this government and of central bank at exactly the time as the UK population needs to be able to trust their leaders.

TAM has resisted the temptation to buy into the bond rally yesterday which many others started to. Chiefly because the uncertain backdrop in the UK doesn’t warrant us investing clients capital into it at this time. As with all scenarios before this and the many still to come, its worth remembering that its darkest before the dawn and there will absolutely come a time for the UK to shine on both the bond and equity front and at this juncture TAM know what to invest into and in what size to capture the best value from the UK but we still see further uncertainty from here for UK inc.

With the pound trading at record lows it might seem that GBP is in a crisis which looks set to deepen. Indeed investors have likened the volatility in GBP to that of an emerging market currency which is certainly not a rosy outlook. The negativity seems inexorably linked to a stock market referendum on the government’s approach to fiscal discipline which is dour.

What would a currency crisis mean for portfolio/UK markets? What would it mean if sterling falls below parity with the dollar?

With the pound falling this adversely affects domestic companies in the AIM and FTSE250 and conversely provides a boost to those in the FTSE100, whom have more of their revenue in international currencies. If GBP hits parity to the dollar this will remain largely a symbolic breach rather than something which will prompt some sort of official fiscal or monetary intervention. However, should cable hit parity then one could reasonably expect the BoE to step in with emergency rate hikes to protect the pound from further falls. This obviously comes with its own downsides when it comes to pricing in a recession in the UK and how UK company earnings are priced as a result which will likely be negative on UK assets.

What is the outlook for sterling?

GBP looks very negative and will likely hit parity before Christmas as a result of both the dour UK scenario but also the US rate hiking cycle which looks set to continue apace. From an investment perspective, anything trading at a steep discount always remains poised to break out and up when the paradigm shifts back in the other direction. Whilst this is hard to envisage in the short term, we see the potential for a pound recovery increasing as we move into 2023 and look towards a FED who might be getting ready to pause their hiking cycle.