The Latest Twists in Westminster

Editors’ Note: MarketMinder prefers no party nor any politician. We are politically agnostic and assess developments for their potential economic and market impact only.

What a difference a day makes. Twenty-four hours ago, Jeremy Hunt was a backbench Member of Parliament (MP) in the UK with two failed Conservative Party leadership bids and no Cabinet position in three years. Now he is Chancellor of the Exchequer, responsible for executing the economic vision of Prime Minister Liz Truss. That is a bit awkward considering he supported her leadership opponent and economic policy foil, former Chancellor Rishi Sunak, in the final stage of this summer’s leadership contest. Out, just days into his tenure, is now-former Chancellor Kwasi Kwarteng, who has endured the insult of getting sacked by Truss simply for trying to fulfill her campaign proposals. Yes, UK politics are getting messy. Again. Breeding immediate policy uncertainty. Again. But the dust shouldn’t take long to settle, which should reveal the country’s deep gridlock and help investors get past today’s jitters.

When last we left Truss and Kwarteng, they were dealing with the fallout from their “mini-budget,” which they tried to sell as a growth-boosting suite of tax cuts and help for households dealing with sky-high energy costs and a cost-of living crisis. When they unveiled the measures, the majority of global think tank/political-types labeled them an irresponsible pile of debt-fueling “unfunded tax cuts.” We didn’t—and don’t—think either viewpoint is right. As we wrote at the time, the plan merely undid one very small, six-month-old rise in the tax that funds Britain’s National Health Service; reduced the basic income tax rate to partly offset tax bands’ not rising with inflation; removed the top 45% tax rate on incomes over £150,000 (leaving the top rate at 40% on income over £100,000); and canceled a corporate tax hike from 19% to 25% scheduled to take effect next year. All in, these changes would have reduced some, but not all, of the stealth tax hike Brits endured this year.

They would have offered modest relief, but they probably wouldn’t have turbocharged growth. With real incomes still falling and other disinflationary forces taking hold, they were quite unlikely to trigger yet more inflation from here. Lastly, with nominal GDP growing rapidly thanks to this year’s inflation, Britain’s tax take is up while debt-to-GDP is falling, and interest payments were just 12.1% of total revenue in the most recent fiscal year. The estimated £72 billion in new borrowing to fund the plan was super unlikely to break the Treasury’s back.

That was our objective analysis. We still hold those opinions. But the economic establishment is prone to bias and clutches its pearls in horror whenever any government anywhere—whether left-leaning or right—dares launch policies that don’t adhere to its worldview. So when all the usual suspects warned about “unfunded tax cuts,” debt problems and an inflationary nightmare, already edgy markets spooked. Long-term Gilt rates jumped. That triggered collateral calls at pensions that had tried to boost returns by purchasing long-term government bonds with borrowed money, forcing them to sell to raise cash immediately. Those forced sales pushed rates higher, causing more margin calls and more forced selling, culminating in intervention by the BoE. Thus, it soon became accepted truth that the government had caused a financial crisis that the BoE had to mop up.

The backlash and market volatility hit Truss and the Conservatives’ poll numbers hard, reopening the wounds of the summer’s leadership contest. You see, Sunak was many MPs’ favored candidate, while Truss found far more favor with grassroots party members. Seeing as how it was Sunak’s tax hikes Truss was trying to reverse, several MPs who supported him saw the backlash as vindication. The knives came out, and it became apparent that the mini-budget as originally written would face a tough road in Parliament. So, the U-turns began. First Kwarteng announced last week that the 45% top tax rate would stay after all. Then, earlier this week, the hot rumor was that he and Truss would U-turn on corporate taxes. That came true Friday, after she fired Kwarteng.

That is a rather curious move, considering the mini-budget consisted of tax changes she promised on the campaign trail. It is also a head-scratcher considering she styled herself as someone who would buck the anti-growth orthodoxy she claimed had taken over the Treasury and City of London. But politics is a dirty business, and we are hard pressed to think of a top pol anywhere who hasn’t turned on a close ally in order to save their own skin. You don’t get to front-line politics if you don’t have a keen instinct for self-preservation, and in Truss’s case, calls for her resignation grew louder with every uptick in long rates. The Conservative Party’s “1922 Committee” of backbench MPs was reportedly mulling how to rewrite the rules to force her out and cut grassroots party members out of the next leadership vote. Firing Kwarteng seems to be a classic attempt at finding cover. Who knows whether it will work beyond this weekend, although the 1922 Committee is supposedly now focusing on trying “to assist her to get back to a sensible level of support,” according to The Telegraph’s reporting.^[i]

As for what comes next, the immediate policy front is a bit uncertain. Kwarteng was scheduled to release a revised plan on Halloween, and that date still seems to hold, giving Hunt little time to assemble his own package. What that will look like is unclear, although he has a reputation as a classic “safe pair of hands.” Meanwhile, Truss has hired career Treasury insiders for key leadership positions, countering her promises to bring in fresh thinking. In a Friday afternoon speech, she paid a lot of lip service to “fiscal discipline,” implying the new budget will be quite watered down. Think of that whatever you like, but we guess that if nothing else, it will probably help markets get past this irrational spurt.

On the political front, uncertainty probably stays elevated for the time being. Labour will likely continue calling for a snap election, and backbench Tories will probably continue complaining about Truss if the party’s poll numbers stay low. Expect the leadership contest’s two factions to keep jockeying against each other. Some party luminaries are already calling for the return of recently ousted PM Boris Johnson. There are a lot of different ways this could go, which could keep markets on edge for a while. But as this simmers down, it all points to a government with far less clout—and far less ability to push legislation—than its 70-seat majority implies.

In our view, this is a tailwind for stocks regardless of which party is in charge. The last two weeks are a shining example of how legislative risk can roil markets. The less Parliament can pass, the less it can create winners and losers, which enables investors to focus more on risk-taking and growth than rumblings in Westminster.