Amid Britain’s recent fiscal/economic/political turmoil, one phrase has recently cropped up frequently: “You can’t unburn toast”.
Loosely speaking, it refers to the un-undoable, permanent damage from making an error, such as trashing your country’s financial credibility.
First things first: burnt toast can be tasty, and we think it’s being unfairly slighted in popular discourse. Also, Cancer Research says it is “unlikely to increase the risk of cancer”, so that makes FT Alphaville happier about some late-night snacking decisions it has made in the past.
Also, you may not be able to unburn toast, but you can scrape it with a knife until it conforms with your own definition of edibility (although at that point your butter won’t melt in as well, making it hard to do a Nigella).
Here’s what that scraping process looks like as a yield chart:
Last Wednesday, we made an attempt to quantify the UK’s moron risk premium — ie “the extra money the UK is paying to borrow because its leaders are a few sandwiches short of a tea party” — and concluded prime minister Liz Truss might cost the country £11.8bn just by being herself.
That article appeared to deal the final blow to Truss, who promptly resigned the subsequent day. We’d recommend you read it before getting into this, not least to become au fait with this new research field’s rapidly developing nomenclature.
After a weekend of plotting and intrigue, the PM at time of pixel was one Rishi Sunak, a Goldman/hedge fund alum, crypto bro, and, perhaps most poignantly, the former Chancellor of the Exchequer.
This is excellent for our deeply serious analysis because it allows us to compare a pre-Truss Sunak-led economy with a post-Truss one. In other words: what’s the residual moron risk premium? How burnt is the toast?
Before we update our calculations, let’s borrow some credibility from Bank of America. In the latest edition of its credit investor survey, published yesterday under the title “Contagion nation”, analysts Barnaby Martin and Ioannis Angelakis said “October’s survey lays bare the reverberations from the UK confidence shock”.
Here’s the key chart (tl;dr, lol @ UK):
So how is Britain’s MRP looking?
As a reminder, here’s our basic formula:
MRP = (Gilt yield-Bund yield)-UKRP
…in which UKRP is the UK’s standard 2022 level of risk premium versus the almighty Bund up to the point when Boris Johnson called it quits in July.
Last time around we focused mainly on the 30-year, but we’re gonna treat you to some other tenors. In the case of 30-years, this is 1 per cent, for 10-years it’s 1.1 per cent, for 2-years it’s 1.4 per cent.
Here’s how MRP moved from early September up to 11:30am BST today (the 2-yr ends slightly earlier, Terminal issues), when Sunak met King Charles and secured the bag. As a reminder, our methodology means zero here represents the ‘neutral’ premium:
Immediate takeaway: for the typically more volatile 2-years, the UK’s MRP has vanished amid the gilt rally following Sunak’s ascension.
At the longer end, it’s clear some problems remain. Before we continue, a brief word from our sponsors, FUD (optional music):
This article on the UK’s moron risk premium and its consequence is premised broadly on the characterisation of the UK gilt market’s recent movements as being primarily based on the ‘Fiscal Event’ in late September, and its implications for pension schemes employing a liability-driven investment model.
We note that some commentators believe the movements to have been primarily a function of the Bank of England’s plans for active quantitative tightening. We note there are several coincident factors, and encourage readers to maintain an open mind. Here’s a good thread, and another, on the angry bird website, and a piece by FTAV’s former editor on the angry cow website.
Welcome back. At the longer end, at the moment of Sunakening, the MRP was 35bps on 10-years and 45bps on 30-years (versus a pre-event Truss-era baseline, T-star, of about 70bps). So a bit more than T-star/2 above UKRP, or roughly two kwartengs. We’ll call this residual/sticky moron risk premium the ‘toastal nation premium’/TNP.
The Office for Budget Responsibility’s ready reckoners, as we referenced last week, say that a 1 percentage point increase in gilt rates costs the UK £16.8bn in increased debt interest spending over 5 years.
The OBR does not appear to clarify what tenor this refers to (if you know, please do let us know in the comments), but Alphaville is happy to split the difference between 10s and 30s at 40bps.
Taking a 10/30-year average over the period and multiplying it by 16.8 lets us see in £billion how much MRP would have cost at various points over recent months:
So right now that’s about £6.7bn over the coming five years, presuming TNP remains fairly stable (an open question at this point). That is slightly more than the cost of reducing the UK’s overseas aid spending back to 0.7 per cent of GDP in 2024/25.
We’re not saying the Treasury will look to match spending/saving on a totally like-for-like basis. Things are way more complicated than that (although it wouldn’t be the least Treasury thing to ever happen). But it’s definitely the kind of thing they’ll look at cutting.
It would certainly be ironic if the main long-term consequence of the brief leadership of Liz Truss, cheerleader of ‘Global Britain’, is for the UK to provide less help for developing nations.
