Seems like bond traders have got a downer on the UK. They should cast their beady eyes over the Eurozone where there is serious trouble on the horizon. Of course the UK government did a pretty lousy job of explaining what their ultimate objectives actually were when Kwasi Kwarteng introduced his huge mini budget and the optics weren’t that good but the reasons given as to why bondholders are becoming so twitchy are ridiculous. Abolishing the 45% tax bracket would almost certainly bring in far more tax than would be lost and create a well needed stimulus within the City of London. Unfunded tax cuts given the effects of fiscal drag are also a stupid reason to go ape. Sovereign bond portfolios are strange animals and work on the basis that the holders invest their printed money in instruments which they know can only be rolled over or inflated away. All the analysis in the world won’t change the fact that is repayment was triggered by a credit event none of it would be repaid. I was around at the sharp end when this merry ground started up in the 1970’s and I remember the banking markets trying to put controls over sovereign risk. Portfolio diversification didn’t work then and it doesn’t work now. Some of this debt is toxic and the holders already know it. The UK is far from being the worst.
Some journalists take a somewhat naïve view of regulated financial institutions and I fear that The Daily Telegraph who are taking aim at the shadow banking sector suggest that just because a bank Like Credit Suisse has reasonable capital ratios it remains a good risk rather than some of the more laissez faire outfits that line the streets of Mayfair. The fact is Credit Suisse made some lousy credit decisions that everyone noticed. Next question is how much more of this is in the balance sheet still? Don’t get me wrong Credit Suisse will be all right one way or another. The shadow banking area has some good players and a few lousy ones. Some of the things I have seen over the past twelve months have shocked me to the core. Nevertheless most of the lenders in this sector are not big enough to cause a bad accident although they could lose some very rich people quite a lot of money.
This is a very good question and bond traders would do well to start getting back to basics rather than training their guns on the United Kingdom. Nevertheless the Daily Telegraph published a piece which seeks to explain why the UK is getting punished so badly by the market? The answer it comes up with are disingenuous. Permanent Tax cuts will grow the UK economy as even the IMF now admits. Less tolerance for inflation within the EU. Tell that to the Dutch and Estonians. The end of cheap money in the UK. Most analysts insist that the UK’s banks are sounder than a lot of their European counterparts. I don’t buy any of these arguments. Nevertheless something is out of kilter in the bond markets would you really like to be holding Greek or Italian risk at the moment? The market has lost track of the fundamentals.