The Lex Newsletter: Bailey’s bind is the consequence of Kwarteng’s unreassurance

Dear reader,

There are two kinds of reassurance. The first does what it is supposed to do. It lifts a weight from your shoulders. The second, more correctly described as “unreassurance”, leaves you sweaty and terrified.

One example of unreassurance would be executives from Credit Suisse calling investors to tell them it isn’t going bust (which it isn’t, by the way).

Shifting focus from Europe’s most chaotic bank to its most chaotic government produces another example. A fortnight ago, untried UK chancellor Kwasi Kwarteng attempted to send a positive message with plans for tax cuts. There was no evidence he could fund these without heavy borrowing.

The fallout from that blunder continued raining down on the Conservatives this week. Kwarteng’s big U-turn — cancelling the abolition of a 45 per cent tax rate for higher earners — made little difference.

The quantum of the saving was low, as Lex wrote. More importantly, Kwarteng’s initial error revealed that he lacked the judgment to intuit the mood of investors or of his own party. His volte-face merely showed he could observe consequences, rather than predict them. To comment on this or any other aspect of our coverage, please email me at [email protected]

Andrew Bailey, governor of the Bank of England, is now in a bind, like Laocoön, the unfortunate Trojan engulfed by the goddess Athena’s pet boa constrictors in our picture.

The bank claimed on Thursday it had staved off a £50bn fire sale of gilts triggered by Kwarteng’s gaffe. It had promised to buy long-dated gilts dumped by panicking investors. Rising yields were threatening to destabilise pension funds whose hedges against lower rates now required collateral injections.

Bailey’s predicament is that his pledge expires in a week. Unless he rolls it forward, gilts could suffer further heavy selling. That could also happen if Kwarteng’s plan for funding tax cuts proves sketchy when published. Unless confidence returns, Bailey is on the hook to give more support.

That leaves him holding down yields at the long end while theoretically trying to drive them up across the remainder of the maturity spectrum to tame inflation.

That has clear implications for our notional Lex-reading investor, who we envisage as a cosmopolitan character with a medium-term time horizon and good looks and taste to boot. He or she should invest in securities less bedevilled by politics and its attendant contradictions.

Unfortunately, investing elsewhere is not an option for people who need to live in their main investment: UK mortgage holders. Borrowers on fixed-rate deals face an average monthly increase of £500 in repayments when they refinance. Falling shares in retailers such as Tesco already point to the squeeze on household budgets.

UK banks will be in a bind of their own when they announce surging net interest income later this month. The optics of that, amid media reports of potential home repossessions, could be terrible. Lex will be looking out for banks using big provisions to shrink reported profits. We also expect upfront promises of debt forbearance.

Dollar bother

Sterling and gilts are weak partly because dollars and Treasuries are strong. Some central bankers are therefore wistfully namechecking the Plaza Accord. This was a 1985 agreement to hold down the dollar via rate tweaks and market interventions.

That is wishful thinking for the moment. Co-ordinated greenback-bashing will become more likely if the dollar remains high for an extended period. In the event of a Plaza Accord reboot, investors should buy gold and selected emerging markets.

China, meanwhile, is still searching for a market bottom. But Lex, to the dismay of some readers, thinks Vietnam’s moment might have already come. The main stock index of the south-east Asian country has fallen about a third this year. An influx of manufacturing work for the likes of Apple means shares are now cheap. And yes, you were right to note that getting money out is still tricky.

Friction is a big issue in emerging market investment. Hence JPMorgan’s decision to keep Indian bonds out of its GBI-EM Global Diversified benchmark. Settlement is difficult, supposedly.

For us, this evoked clashing Indian stereotypes of sclerotic bureaucracy alongside slick technology. Our conclusion was that there is nothing wrong with Indian bond settlement. It may not suit US and European investors, but perhaps that is their problem, not India’s.

X marks the strop

Over in the US, the Twitter floorshow continued with Elon Musk apparently deciding to press ahead with his $44bn takeover of the microblogging website. Call me old-fashioned — everybody else does — but this would be a victory for the US market and fair dealing within it.

Musk is a remarkable entrepreneur (see Roula Khalaf’s lunch with him here). But if a businessperson publicly shakes hand on a deal, they should go through with it. You can see why Musk did not want to do so in the case of Twitter: Lex calculated that the premium, allowing for the post-agreement slump in tech stocks, is about 300 per cent.

We think Musk’s showmanship and huge net worth will allow him to raise enough funds to do the deal. He has nebulous plans to turn Twitter into an “X app” acting as a portal to the currently non-existent metaverse. That will be catnip to his fans, no doubt.

We think the US internet is now too firmly divided into walled gardens for an everything app resembling China’s WeChat. But it is amazing what hefty development funding can achieve.

Automated for the people

I will close this letter with three technologies that caught our eye this week:

• Ebbing enthusiasm for driverless cars was reflected in a $20bn drop in the value of systems company Mobileye. Lex thinks cool assessments of the viability of autonomous vehicles are replacing earlier hype. We are backers.

• Edtech group Duolingo has chosen animation studio Gunner as its first acquisition. Making online learning fun should counterbalance drawbacks that include a lack of face-to-face social interaction.

• Indoor farming in automated greenhouses by the likes of Gotham Greens reduces labour costs and distance to market. We are not, however, enthusiastic about vertical farming under grow lights. This has been breathlessly promoted because it is like, y’know cool, what with the whole verticality thing. In reality, piping the sun’s energy to plants inefficiently via electrical equipment is plain dumb when you can grow plants directly in daylight.

However your garden grows, enjoy your weekend,

Jonathan Guthrie
Head of Lex