The Bank of England followed the Federal Reserve’s response to the ‘black swan’ that is COVID-19, it reduced interest rates by 0.5 percent, leaving rates still marginally positive at 0.25 percent. Luckily for investors, the move got a more positive response then it did on the other side of the pond, boosting the FTSE 100 when the policy was announced.
However, there are already signs that potential gains will be short lived, perhaps due in part to a budget delivered by what many would deem a ‘green’ Chancellor, Rishi Sunak. Also given the synchronising nature of the Fed and bank of England’s policy decisions, the market had largely priced in a large rate cut.
A quick look at history shows that manic rate cutting has failed to prevent the onset of a bear market and ultimately a recession, such as 2000 to 2003 and 2007 to 2009.
Given that globally there have been 38 rate cuts this year, as opposed to just three hikes, the Bank of England had to act and in many ways the Fed had already written the speech.
However, with $255 trillion of debt now in the global financial system, as has been said before, when a recession does hit, what tools do central banks have left? The ECB, with its rate of minus 0.5 percent, has little room for manoeuvre in terms of rates, which is why Western Asset Management’s Andreas Billmeier suggested that further exemptions from negative rates for banks’ reserves may be a tool used more.
The Bank of England isn’t in negative territory (yet) and has a number of policy options open. It could engage in asset purchasing, although this will lead to a further increase in what is a historically high level of debt. The announcement of £156 billion of gilt issuance was below market expectations and given the bonds are of shorter duration, it begs the question what will the appetite be for this paper especially as rates were cut on the same day?
It could follow Japan’s lead and introduce yield curve control, buying bonds to keep the keep the 10-year gilt where it wants it. This would have significantly less impact on the UK’s balance sheet.
Perhaps it’s time to call in Milton Friedman’s helicopter money, a concept revisited after Japan’s lost decade which involves the state directly funding private enterprise without the pesky interference of fiscal authorities. The idea was brought back to the fore by former Fed Chair Ben Bernanke in 2002 as a means of countering deflation.
While the term has evolved from its original meaning of dropping money into individuals’ hands, it straddles the line between monetary and fiscal policy as seen with the introduction in 2008 of the Economic Stimulus Act which was essentially a tax rebate for US citizens.
But we’re not there. Yet. Of course the budget took place yesterday and Mr Sunak, perhaps looking to win headlines, announced a series of crowd pleasing freezes to duty on 'essential' items such as various forms of alcohol.
What’s more relevant in today’s markets is what do about the oil crisis, a big part of the FTSE 100 (which explains its nigh-on 25 percent fall year-to-date) and also a large employer in the UK. This is where we find out if all this talk about ESG is really being considered or just paying lip service to those worried about climate change.
Derek Leith, EY’s Global Oil and Gas Tax Lead, said in a statement: “The new Chancellor’s decision to hold steady and make no legislative change for the oil and gas industry is a welcome move.
“In recent years we’ve seen significant change to the tax landscape for the oil and gas sector, with successive governments acknowledging the maturity of the basin and the need to have stable fiscal conditions for investment. Last weekend’s drop in oil price demonstrates that there is significant volatility in the sector with global demand faltering and supply side discipline disappearing.”
He added that a stable oil industry is vital for a repositioning of the energy markets towards renewable, non-carbon sources. However, the UK is hardly a global player in oil production despite many said companies being listed on the FTSE 100.
In an episode similar to 2015, a price war between Saudi Arabia and Russia saw oil fall by over 30 percent in two days, further elevating the market volatility which was already impacted by COVID-19. According to investment bank Jefferies, some of the names that held up best against the last oil rout include Unilever, BT and National Grid.
Therefore in an environment of heightened volatility, stoked by COVID-19 and the ensuing oil stand-off, it’s reasonable to ask how much the new Chancellor can do to offset pressures on the market, especially with his maiden budget. Fundeye has already suggested ways to play this ‘black swan’ event, for instance a focus on quality funds and defensive trusts, which may include counter-cyclicals such as utilities providers, could be the first building blocks.
