The Cambridge Weekly – 31st October 2022

US slows, Europe’s winter outlook improves, UK back to start

The most turbulent October experienced by UK bond markets since 2008 is drawing to an end and one could easily get the impression nothing of significance happened. Sterling is back to where it traded just before that fateful 23 September ‘fiscal event’, and bond yields are likewise roughly back to where they started in autumn. This is good news: it shows the UK still has effective institutions capable of reversing errors and preventing major collateral damage. Unfortunately, though, some of its credibility in international capital markets has been lost. As a result, the government’s fiscal headroom of what it can and cannot do when the absolute need arises has most likely reduced.

After fiscal fiasco is Britain back on the straight and narrow?

After fiscal fiasco is Britain back on the straight and narrow? Throughout her short and not so sweet premiership, Liz Truss and her team pushed the narrative that global forces were to blame for the chaos in markets. The band kept playing this tune even as the ship was sinking. Indeed, Truss used her last Prime Minister’s Questions to tell MPs that sky-high inflation and rising interest rates were because of the Ukraine war and global energy supplies. While nobody seemed particularly convinced, there is certainly some truth to this. Government and corporate credit conditions had deteriorated markedly over the last few months. And while sterling fell sharply, the continued strength of the US dollar against every other currency has been an inescapable part of the story.

How strong can the dollar go?

US currency strength has been one of the defining features of this year. For UK investors, this was made painfully clear at the end of last month, when sterling was dragged to its lowest ever value against the dollar. Markets have since stabilised but even so, the dollar is still up by more than 16% against the pound this year. While part of that is UK weakness, US strength is the much more prominent story for global investors. The dollar has floated at or above parity with the euro for more than a month now, while the dollar index – a broad measure of its value against a basket of other currencies – has gained some 14% in 2022.