On Thursday (October 31), investors quickly sold British assets, leading to a sharp drop in British bonds, stocks and sterling. GBP/USD hit 1.2843, the lowest since August 19, because they strongly opposed the New Labour government's willingness to increase lending and take the risk of faster inflation. On Friday (November 1st) in the Asian market, GBP/USD hovered at a low level and is currently trading around 1.2895.

Due to investors' expectation that the Bank of England will reduce interest rate cuts in response to Chancellor of the Exchequer Rachel Reeves' budget proposal on Wednesday, the sell-off has pushed short-term borrowing costs to their highest level since May. The repricing of interest rates has caused ripples in UK assets, with the FTSE 250 index experiencing its worst day since early August and the pound falling against all major currencies.

Although the scale of this market fluctuation is not as big as the impact caused by Liz Trass's tax reduction plan without financial support two years ago, they highlight the situation that Reeves must walk a tightrope to maintain market stability. The Labour Party once touted its return to fiscal prudence, but now finds that the bond market is willing to punish what it sees as overly loose fiscal policies.

Evelyne Gomez Liechti, a strategist at Mizuho International, said, "There seems to be an inflation panic at the moment." Investors "are still concerned about the potential inflationary pressure, degree of easing, and how much it will change the Bank of England's response to interest rate cuts that the budget may bring

On Thursday, the yield of two-year treasury bond soared by 21 basis points, closing up 12 basis points to 4.44%. The yield of 10-year treasury bond once rose 18 basis points to 4.53% - a small part of the increase of about 100 basis points in treasury bond yield in the three days after the Truss budget - reaching the highest level in nearly a year.

According to swap pricing, the market currently expects four interest rate cuts by the end of 2025, each by 25 basis points, compared to last Friday's expectation of five cuts.

Over time, the sell-off spread to other assets. The pound fell to its lowest level since August, with home builders leading the decline in the UK stock market. Due to the surge in swap rates used to price mortgage loans, Taylor Wimpey Plc fell 6.7%, the largest decline since 2020, Persimon Plc fell 7.5%, and Barratt Redrow Plc fell 5.1%.

Other industries sensitive to yield have also experienced declines, including real estate investors, retail, and utilities. Goldman Sachs' basket tracking stocks of companies with high UK sales exposure fell 2.6%, the largest drop in nearly three months.

Huge supply

The UK Debt Management Office said on Wednesday that it would sell 297 billion pounds ($386 billion) of government bonds in this fiscal year, the second largest target on record. Although this is only slightly higher than expected, investors point out that official forecasts suggest an additional borrowing of approximately 142 billion pounds over the next five years.

These funds will be used for what the independent Budget Responsibility Office calls' one of the largest fiscal easing policies of any fiscal event in recent decades'.

Megum Muhic, strategist of Royal Bank of Canada, said: "This is not a healthy repricing of treasury bond." "The market does not seem to believe that the announced spending measures can promote British economic growth. In addition, there are more treasury bond to sell."

The pain of British assets is a warning to other countries around the world, many of which are launching their own large-scale financing plans. Investors in US assets are preparing to welcome the winner of next week's presidential election to launch an aggressive spending plan that may increase borrowing and deficits. Wall Street veteran Ed Adney warned this week, "It can be imagined that bond militias are definitely gathering

This is also a setback for Reeves, who went to great lengths to prepare the market for her borrowing plan and expressed her intention at last week's International Monetary Fund annual meeting. In view of the market sell-off caused by the Labor government's frequent attacks on Truss's mini budget, the fall in treasury bond bond prices is politically sensitive.

Reeves attempted to appease the financial markets, stating that the primary commitment of the Labour government is economic and fiscal stability. Reeves said in an interview with Bloomberg TV on Thursday, "We have more space left for us than the previous government, which is important. We have now placed public finances on a stable and robust track

Inflation outlook

The trend of this week ended a bad year for British bonds. As the market believed that the Bank of England would lag behind the ECB and the Federal Reserve in easing policies, British bonds underperformed bonds of other countries. Since December last year, Bloomberg's UK treasury bond return index has fallen by about 3%, while the comparable index of the euro zone and US treasury bond has risen by 1%.

Traders said that the disorderly price trend on Thursday caused British treasury bond bonds to run counter to their global counterparts again, which was exacerbated by investors being forced to close their positions and the so-called steepening of the yield curve. The spread between two-year and 30-year UK treasury bond yields narrowed to 7 basis points. They said that some investors also closed their positions in British treasury bond bonds, which outperformed other bond markets.

James Athey, fund manager of Wanbao Shenghua Investment Management, said, "Like the UK market, the lack of liquidity has exacerbated volatility." "With the approaching US election and the possibility of more unfavorable news for bonds, we may find it difficult to easily find willing buyers, so the possibility of an excessive pullback is very high

In the fiscal measures announced this week, the government raised the minimum wage and a tax for employers called National Insurance contributions. The Budget Responsibility Office stated that the entire plan will increase inflation by 0.4% over the next two years and raise the Bank of England interest rate by 25 basis points, higher than investors' expectations.

Although the overall price increase in the UK has slowed down to below the Bank of England's 2% target, the inflation rate in the service sector remains at an annual rate of 4.9%.

Jack McIntyre, fund manager of Brandywine Global, said: "The bond market is nervous about all financial issues, and the UK treasury bond bond market is no exception." "More spending, more issuance, and a little more taxation. This is not what bond volunteers want to hear."

Nevertheless, the bidding amount for the 30-year green bond on Thursday was 3.15 times the issuance volume, highlighting the healthy demand in the market for locking in higher yields. The open position contract (an indicator measuring the open position of 10-year treasury bond bond futures in the UK) remained basically unchanged this week, which indicates that traders have not changed their bets on the future direction of the yield of treasury bond bonds.

Mohit Kumar, chief European strategist of Jefferies, said: "The immediate concern of the market will be the financial expansion funded by the issuance of long-term bonds." "We do not expect any Liz Trass moment, but we expect that financial concerns will continue to exert pressure on long-term bonds."