Fiscal dominance?

Chancellor looks to blame Bank

Chancellor Kwasi Kwarteng says any market volatility next week would be down to the Bank of England, saying any instability “is a matter for the governor”. This is extremely unhelpful and points to the fiscal and monetary sides being at odds with each other. I am no fan of Bailey – too slow, too arrogant, not prepared to take the time to communicate well; but Kwarteng is a danger. Bailey is attempting to assert independence by sticking to this Friday deadline (a bluff?). Kwarteng knows that everyone knows the instability is down to the Budget, despite some shocking gaslighting from certain corners of the political spectrum and, far worse, certain commentators. So he wants to shift the blame for what is likely to come. The Bank meanwhile has found itself in a corner where it’s damned if it does and damned if it doesn’t; ‘fiscal dominance’ looms ever larger – where the CB is forced to use its monetary powers to keep the cost of spiralling government debt down - who blinks first? The Government ought to back down and let the Bank get on with fighting inflation. Bailey seems intent on pressing this – three days to get your houses in order - and this could lead to near-term volatility and longer term financial instability until the political/fiscal bit is back under control.

UK gilts remain in focus – the 30yr ticked up above 5% yesterday, before pulling back to around 4.8% as the BoE snapped up £4.4bn in gilts, its biggest day so far. There is still considerable uncertainty about what the Bank of England will do after the market intervention ends on Friday. Sterling trades around the $1.10 anchor for now.  

More inflation, more tightening

Minutes from the latest FOMC meeting show policymakers believe higher rates are here to stay: higher for longer as I have been saying for ages now. And if there is an overshoot, it’ll be too much tightening, not too little. “Many participants emphasised that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action,” the minutes said. As I noted after the nonfarm payroll report last Friday, the Fed has barely made a dent in inflation and the labour market is strong. Today’s CPI release will be above 8% or thereabouts but it doesn’t really matter- it has a long way to come down still. Fed officials are worried that the longer it stays at this kind of level the more expectations become ingrained. Forget any natural pivot – the Fed keeps on going until something snaps. So expect 75bps in Nov and another in Dec unless there is a major crisis before then.

 German inflation hits 70-yr high

The pressure is no less acute this side of the Atlantic: German inflation rose to a 70-yr high 10% in September, up 1.9% month-on-month. This only adds to the pressure on the European Central Bank to do more, but there is no symmetric response from the euro from higher rates now, with EURUSD under 0.97.

Stocks weaker

Stocks opened lower in Europe after Wall Street notched a sixth-straight down day. The FTSE 100 dropped under 6,800 while the DAX retreated to around 12,100 before reversing higher to 12,200 in the first hour of trading. UK homebuilders continue to drop as mortgage rates rise. The S&P 500 fell a third of a percent to 3,577. After the breakout last Friday, Brent has pulled back to the top of the chancel – US inventories today after the API reported a 7m barrel build.

 Today’s markets

All eyes on the US CPI print at 13:30 BST. Expected to slip to 8.1% from 8.3% prior, with core at 0.4% from 0.6% on the month.