UK bonds posted some of their biggest gains on record as investors bet incoming PM Rishi Sunak will turn the page on weeks of turmoil dogging the nation’s markets and restore credibility to economic policymaking.
Short-dated notes led the rally with the two-year yield falling by the most since 1993 after Sunak – a former chancellor who had issued a warning over Liz Truss‘ “fairy tale” tax cuts – emerged as the winner in the race to succeed her. The gains were supercharged as traders pared bets on future rate hikes. The pound rose too, before falling 0.4% to $1.13 as of 5.42pm in London. It’s languishing well below the peaks reached during the first leadership contest over the summer, weighed down by huge economic headwinds ahead (the outlook for the UK’s credit score was revised to negative by Moody’s Investors Service on Friday).
Britain’s main equity indexes closed higher on Monday after Sunak looked set to become the next PM following other candidates exiting the race. The blue-chip FTSE 100 gained 0.6%, while the domestically focused FTSE 250 index jumped 0.8%.
Truss resigned last Thursday following a market meltdown that pushed yields to their highest in years, forced the central bank to step in to stabilise markets and eventually prompted her to backtrack on plans for a vast fiscal stimulus. Investors expect Sunak will draw a line under the economic damage.
“For now, it’s relief that ‘total chaos’ is over,” said Marc Ostwald, chief economist and global strategist at ADM Investor Services. “His credit with markets comes from having been a steady hand as chancellor and being a polished communicator who is not going to ‘go off piste’ like the Truss government.”
For his part, Sunak was quick to issue a warning on Monday that the UK faces a “profound economic challenge”. The two-year gilt yield dropped 37 basis points (100bps = 1 percentage point) on Monday to end at 3.43%. Longer notes also rallied hard, sending the 10-year yield to 3.75%, the lowest since the day former chancellor Kwasi Kwarteng first announced his so-called mini budget.
Attention is already turning to next week – the next Bank of England meeting. While a 75bps hike is still fully priced, expectations of a bigger increase have faded now.