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Pound, gilts and UK stocks stage cautious rebound

British assets rebounded on Tuesday as investors welcomed signs of a Fed pivot and the U.K. government's U-turn on scrapping the 45p tax rate

The pound, gilts and UK stock market rebounded after a turbulent week as global investors reacted to attempts to stabilize Britain’s economic ship.

Further support for markets came as investors weighed the possibility of an interest rate pivot from the US Federal Reserve.

The FTSE 100 and FTSE 250 were up 2% and 2.6%, respectively, by late afternoon after weak U.S. manufacturing data on Monday raised the odds that the Fed might choose to pause price hikes. interest rates, to prevent the economy from slowing down too suddenly.

Attempts to signal greater fiscal discipline and the abandonment of plans to scrap the UK’s 45p tax bracket also helped the pound climb 0.3% to $1.14, while gilt yields fell across the board.

British assets rebounded on Tuesday as investors welcomed signs of a Fed pivot and the U.K. government's U-turn on scrapping the 45p tax rate

British assets rebounded on Tuesday as investors welcomed signs of a Fed pivot and the U.K. government’s U-turn on scrapping the 45p tax rate

Yields on two-year, five-year and 10-year gilts fell 22 basis points, 18 basis points and 15 basis points today.

However, at 3.71%, 4% and 3.8%, respectively, they remain above the levels seen before the Chancellor’s now infamous mini-budget, despite the intervention of the Bank of England since the event.

Meanwhile, 30-year gilt yields, specifically targeted by the Bank of England, fell back to pre-mini-budget levels at 3.84%.

Speculation over a Fed pivot didn’t just benefit UK assets, as the euro and European and Asian stocks fared well on Tuesday.

All major European exchanges rose more than 2%, pushing the Euro Stoxx 50 up 2.7%, while Bombay’s BSE Sensex and Tokyo’s Nikkei 225 rose 2.3 and 3% respectively. The euro rallied against all major currencies.

Risky assets have taken a hit this year as central banks around the world embark on monetary tightening to rein in soaring inflation, at the risk of triggering a recession, and the potential for a Fed pivot has boosted the investor optimism.

Andy Sparks, head of portfolio management research at MSCI, said: “The chances of a pivot are much greater in 2023.

“The Fed looks set to hike rates another 1.25 percentage points. So far, the Fed has had the luxury of taking a hawkish stance when the labor market has been hot. But the picture may change as we enter the new year.

“The easy pivot path for the Fed will be if inflation has come down significantly.” The real challenge will be if inflation has not come down as much as hoped, but the economy has weakened. In such a case, the Fed’s resolve to continue with rate hikes will be tested.

While the FTSE 100 remains down around 6% for 2022, this represents an outperformance against its global peers which have fallen further.

The index has benefited from its export-focused and dollar-earnings participants, while the more domestically focused FTSE 250 has fallen more than 25% this year.

Head of markets at interactive investor Richard Hunter said today’s rally in UK equities “may have been welcome, but it could also be transitory.”

He added: “The UK government’s decision to reverse part of its previous tax cut plan also had a disproportionate positive effect on overall sentiment, with the pound recouping some of its previously precipitous losses following the announcement. initial.

“Greater volatility is likely to follow as the global economy grapples with persistently high inflation and central banks attempt to tame it without tipping into recessionary territory.”

The pound remains down around 16% against the US dollar since the start of 2022 and experts warn that it is unlikely to regain ground in the short term.

Seema Shah, chief global strategist at Principal Global Investors, said that while the pound may have rebounded to pre-“tax event” levels, this should not be taken as an endorsement by markets of ” Trussenomics”.

She added: “It is true that the pound has had a mini-rally, but firstly these were historically low levels to start with and secondly the new value of sterling prices in the sharp rises rates that have been necessitated by the market’s chaotic response to the Chancellor’s growth plan.

“To be back where we were – but with a potential mortgage crisis now baked into the cake – is hardly a triumph.

“Further rises in the pound could in fact tell us that investors think the Truss/Kwarteng axis can be brought into line with more orthodox economic thinking by MPs who have been quick to go public with their skepticism and have threatened to vote against their own party – the complete opposite of markets that “believe” the government’s vision.

“It could even indicate investors’ view that the chances of either – or both – of the Prime Minister and Chancellor leaving their respective posts sooner than expected are increasing. What at first glance looks like a cautious vote of confidence in the currency markets could, in fact, be anything but.

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