Prime Minister Liz Truss resigned yesterday. But why so little market reaction to the news of the resignation of the shortest-serving British Prime Minister in history?
This is, after all, someone who gilt investors and FX traders distrusted. It was their negative reaction to her economic policies that triggered the current political crisis.
Yet markets appeared indifferent. The pound rallied a little on the news of Truss’ resignation but then gave back most of its modest gains. Gilt yields fell a smidgen. The FTSE 100 and FTSE Small Cap stock market indices were marginally up over the day.
The answer is simple: investors continue applying the ‘moron premia’. They are likely to do so until a clean sweep is made of the populist wing of the Conservative Party. This may be delayed if a Truss replacement comes from that wing; hence the premia remain in place.
It is unclear whether Chancellor Jeremy Hunt’s Halloween Budget, due on October 31 and likely to include a package of unpopular tax hikes and spending cuts, will take place. Which new Prime Minister wants to impose up to £40bn of tax hikes and spending cuts, to balance the books when the Conservative Party is already down to a 20% public approval rating?
News that former Prime Minister Boris Johnson may secure enough votes from MPs to go through to the second round is an example of the dangers ahead. He was never slow to spend public money and was only reigned in by his then Chancellor Rishi Sunak.
The emergence of the ‘moron premia’
From July onwards, government bond yields worldwide began to climb as it became clear that central banks would need to be more aggressive in raising interest rates than had previously been expected.
UK gilt yields saw more dramatic moves than yields in other developed bond markets as it became clear that Liz Truss would win the Conservative Party leadership contest. The growing yield gap became known in September as the ‘moron premia’. A cruel term reflecting the market’s view of Truss’ public spending promises, financed with increased borrowing.
Given the UK’s already large budget and current account deficits, Truss’ apparent zeal for fights with the EU over Brexit issues, and talk of an expensive subsidy to UK households to protect them from large energy price increases, investors were nervous that tax cuts would simply fuel inflation, push down sterling and aggravate the country’s problem with low long-term GDP growth.
Truss’ team appeared to have no sense of the nervousness of the markets to her policies. Many of the MPs and Conservative Party members who voted for her continue to deny the disconnect between her policies and economic reality, preferring to blame plotting by Sunak and other moderate members of the Tory party for conspiring against her.
Therefore today’s market stability is not a sign of confidence
The most likely successor to Liz Truss will be one of three: there are two strong contenders from the last contest, Sunak and Penny Mordant. MPs dislike Sunak to the party’s right, and many party members, partly because Sunak’s resignation as Chancellor triggered the end of Johnson’s own premiership. Mordant is considered a political lightweight but is popular with party membership.
Then there is Boris Johnson, who is expected to run with a claim that he has a ‘mandate from the electorate’, since he was PM when the last general election was held. Many MPs distrust him, but he is popular with the membership.
Sunak might be considered the safer pair of hands. He has experience as a Chancellor who is prepared to raise taxes and accurately warned of the damage Truss might do to the economy. But to unite the party and ensure his survival as PM, he must include the right-wing/ populist side of the party in his government. The part of the Conservative party that loathes him and that the markets most fear.
The new Chancellor, Jeremy Hunt, may be removed by a new Prime Minister who hasn’t the stomach to push through tax hikes and spending cuts. The much-anticipated Halloween budget and medium-term economic outlook that he promised to deliver at the end of the month may be altered to a more populist agenda, risking the markets’ wrath.
The ultimate decision regarding who replaces Truss rests with the Conservative Party members. These people voted overwhelmingly for Truss, rather than Sunak, in the summer’s leadership race, despite the apparent weakness of her proposed economic policies.
The membership harbours conspiracy theories of anti-Truss plots, maintaining a distrust of ‘experts’ and ‘elites’. These ideas, sown and nurtured by the supporters of Brexit over the last decade, are challenging to undo.
So the ‘moron premia’ on gilts and sterling remains. It will persist until the ruling Conservative Party rids itself of the populism that infected it during the Brexit debate, which will not be soon. It will likely go perhaps by cutting the membership out of the leadership selection process or when another party (or coalition of parties) takes power.
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