UK budget and Bank of England pivot
The United Kingdom’s new government unveiled its budget at the end of last week, with a sweeping set of tax cuts at its center. Financial markets reacted quickly in response to what amount to be the largest tax cuts since 1972. Yields on long-term UK debt rose as much as 100bps, and the British Pound (GBP) sold off as much as 9%. Within three business days, the Bank of England (BoE) surprised the market by canceling planned sales of government bonds (Quantitative Tightening) and instead announced its intent to purchase long-dated government bonds (Quantitative Easing). The combination of previously announced energy stimulus with sweeping tax cuts proved too much for interest rate markets. As we have discussed, a dramatic rise in interest rates in such a short period of time has all the makings of unintended consequences. Just as the BoE announced QE, there were reports that UK pensions could not meet margin calls given the dramatic moves in rates, and the Bank of England was the first to “blink” in announcing a change in tone back towards a looser monetary policy.
This was a critical development. While the market initially responded with rates across the globe falling and risk assets rallying, how things evolve will determine the credibility of central banks going forward. It is also important to note that if UK pensions found themselves in trouble, other problems are likely lurking.
After the election last weekend, the Brothers of Italy, the far-right party, is set to take control of the government in Italy. Led by Giorgia Meloni, the first female prime minister of the country, this is the rightest-leaning government in Italy since WWII. As we had previously written, there is momentum for right-leaning candidates to take over the leadership of many European countries. We believe this is in response to the current inflation and energy crisis the continent finds itself in. While it is still early, it is worth paying attention to changes that emanate from these new leadership regimes.
Status of Private Equity / Private Credit
Given the new interest rate regime, the conversation in the alternative investment industry has shifted to re-examining its risk/reward. Private equity and private credit strategies proliferated in the low-interest rate regime post the 2008 financial crisis. Private credit was pitched as a yield alternative in a low-interest world, while private equity benefited from cheap debt financing and rich valuation multiples. Unironically, we have recently seen a proliferation of private market strategies geared towards individual investors. While we believe in leveling the playing field, our concern is that the timing couldn’t be worse for the individual investor. Given that interest rates are back to pre-financial crisis levels, we believe it is important to re-underwrite these strategies' relative risk/reward attractiveness. We believe institutional investors are likely to hold or decrease their private market exposure, something for individuals to be aware of.