Bargain-basement Britain

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Writing about UK macro from the UK right now is like when everyone you meet keeps gently asking “how are you doing?” — and that eventually prompts you to realise you’re having an emotional breakdown.

Jeremy Hunt delivered his first Mansion House speech as UK Chancellor at the Financial and Professional Services Dinner yesterday evening. “Sound money” and “more IPOs pls” was the basic gist (full speech here).

But, err, how is the UK actually doing?

“In the context of the last 20 years, UK equities and credit are the cheapest global asset classes we can find,” says a Morgan Stanley note published Monday morning. Here’s the chart:

Its analysts chalk this poor performance up to uniquely pessimistic condition in the wake of the mini-Budget meltdown last autumn, and the UK’s surprisingly solid growth performance since then. They don’t see a recession coming, but warn that “risks are rising, however, with a likely challenging autumn ahead”. The prognosis for stocks is mixed:

We do not expect UK large-caps to outperform their global peers over the next few months, given an inferior EPS trajectory and the ongoing outperformance of Growth stocks. However, UK mid and small cap stocks (9-11x N12M PE) look cheap and would garner interest if a rollover in UK inflation can lift UK macro sentiment.

Is there any silver lining? Well, the poor performance can be chalked down at least in part to sterling strength, which has the double-hit effect of further eroding already-negligible foreign buyer enthusiasm by making UK assets more expensive, and eroding the value of overseas earnings for London-listed internationals.

Here’s Goldman on the pound:

Despite all the hand-wringing, Sterling is the best performing currency in the G10 this year. But recently it has been roughly flat against the Euro despite nominal rates moving further in GBP’s favor since mid-June. So has Sterling’s typical beta to rates broken down, like it did last Autumn, and is that a risk to the currency’s strength? We do not think so.

Goldman’s theory is that an apparent disconnect between nominal sterling rates and a “roughly flat” EUR/GBP is because nominal rates are stupid “imperfect” proxies. The relationship with real rates is, they claim, flatter, tighter and more instructive:

That does not mean, however, that everything’s great. Goldman adds that the UK is not exactly doused in market confidence currently:

Still, there are clear signs that the market is worried about a replay of last year’s sterling collapse. In particular, upside surprises in core inflation this year have yielded negative FX reactions, despite large fixed income selloffs at the same time . ..

While a more hesitant policy response remains an important risk, we think sterling should benefit from the required response to a tight labor market and evidence of more persistent inflation pressures. Sterling’s strength should have staying power.

If even that’s too bullish for you, there’s Nomura’s Jordan Rochester, who reckons next week’s CPI reading could be a turning point (though he’s careful to note how laggy services inflation has been). Here are his arguments for a weaker pound:

1. GBP positioning data suggests “Sell me . . . please!” – if history is any guide, GBP positioning rarely holds onto these levels. Overall, non-commercial net long GBP positions are at levels ($4.2bn) last seen in 2018 … which was a good level to sell GBP/USD.

2. By the time the BOE could even consider 7%, inflation is likely to be a lot lower? Both our leading indicators for services inflation and manufacturing turned lower months ago and suggest strong disinflationary pressures ahead. The key question is when the lags will play through. Give it one weak CPI print and minds could quickly change (or lean back on growth figures again). The idea of 7% seems odd given how much inflation is likely to fall thanks to energy prices and Global goods disinflation coupled with material weakness in the UK housing market likely to play on through.

3. Labour market data is the most lagged variable, but surveys suggest weakness there to come as well: This week we have the UK labour market report, and it is unclear why it should give a materially different message to last month’s strong wages data, as it remains the most lagged variable in the economic cycle to track. But it could be slightly softer than last month. Our Economics team expect a slower 0.4% m-o-m pace of underlying wage growth, an unchanged unemployment rate (3.8%) and a 150k q-o-q rise in LFS employment.

How about gilts? Royal Bank of Canada has what amount to a classier take on Moron Risk Premium, except the risk is now Mo-netary instead of Mo-ron:

10yr gilts currently yield around 130bp over the average of 10yr Bunds and USTs – almost exactly the level reached in September 2022 and compared to around zero spread that prevailed before the mini-Budget.

The blowout in spreads in September was all about the credibility of UK fiscal policy, as evidenced by the simultaneous blowout in UK sovereign CDS spreads (black line; again against 50/50 Germany and US). The current widening of spreads has seen no such widening in CDS spreads and seems to be driven by monetary rather than fiscal policy credibility.

The blowout in spreads in September was all about the credibility of UK fiscal policy, as evidenced by the simultaneous blowout in UK sovereign CDS spreads (black line; again against 50/50 Germany and US). The current widening of spreads has seen no such widening in CDS spreads and seems to be driven by monetary rather than fiscal policy credibility.

So:

— cheap stocks
— cheap gilts
— cheapening sterling?

It almost sounds attractive. What’s the catch?