A post recently appeared on my Bloomberg timeline that headlined: ‘BoE’s Bailey Says Truss Risk Premium on UK Assets is Gone’. Being overweight in some UK assets, I wondered what Bailey bases this on.
So I look at some asset classes that were hit hardest by the panic sell-offs caused by then finance minister Kwasi Kwarteng’s mini-budget. Just a refresher: that mini-budget consisted mainly of tax cuts for high-income earners that were not compensated elsewhere in the budget.
The chart below shows the performance of nominal government bonds from the US, the UK, and the Eurozone.
The chart clearly shows the impact of the mini-budget. UK government bonds performed about 10 per cent worse than their US and Eurozone peers during September/October. But more importantly, UK government bond prices are still sharply lower than before the budget saga. This is not the case for US and European government bonds. Surely that looks suspiciously like an idiosyncratic risk premium on UK government bonds.
The next chart shows the performance of inflation-linked bonds, again from the US, the UK, and the Eurozone. The pattern is similar to the chart above, but more pronounced. UK inflation-linked bonds fell 40 per cent(!) in September against a 6 per cent drop for US and Eurozone inflation-linked bonds.
Moreover, prices are still significantly lower than before the budget crisis. Some six years of yields have “disappeared” for now. What Bailey probably meant by his comment is that markets are returning to normal. His comment that the Bank of England managed to sell 19 billion pounds worth of (mortgage) bonds without market impact also suggests this. But that is not the same as assuming that the risk premium on UK assets has disappeared.
I conclude just the opposite. Do whatever else you want with this information.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer.