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Markets benefit from news that a government U-turn is possible

Written by Sophie Lund-Yates, Lead Equity Analyst at Hargreaves Lansdown

The FTSE100 reacted positively yesterday, and is expected to do the same again today, on news that the government may finally be heeding warnings and is considering a reversal on more of its planned tax cuts.

Anxiety around the enormous funding gap needed to pay for the cuts has triggered sharp market turmoil the UK had hoped not to see for a long while following the pandemic. Chancellor Kwasi Kwarteng won’t be blind to the effect flying home from his Washington DC trip early will have – there is allegedly no precedent for a chancellor returning early from the IMF event for personal reasons.

There is a sense of urgency in this move and it would seem the market is optimistic that Kwarteng’s romcom-worthy dash through the airport suggests a dramatic reconciliation between stubborn existing policy and the U-turn investors have been waiting for. It’s worth keeping in mind that the FTSE will remain over-sensitive to any changes from here, if U-turns fail to materialise, or are deemed too small, we’re likely to see an adverse reaction.

The availability of mortgages and consumer and corporate credit is expected to shrink in the latest tangible sign of the weakening economy. Higher interest rates and the nerve-wracking economic outlook, which has been compounded by the higher-than-expected inflation reading in the US this week, are all contributing to a lower risk appetite for lenders. This will have a knock-on effect for consumer spending power, and also has the potential to take the wind out of the house market’s already faltering sails. The number of people defaulting on their loan payments is already increasing which suggests worse is to come.

This news comes as investors’ attention turns to the imminent earnings releases from the US’ major banks. JPMorgan, Wells Fargo, Morgan Stanley and Citigroup are among those reporting as the Dow and S&P 500 rallied 2.83% and 2.6% yesterday. Spectators will be looking for insight into the economy, including borrowing rates, default levels, cash balance changes as well as investment bank activity. Banks are squarely in the firing line for the effects of a weaker economy, and it’s highly likely that we’ll be seeing some hefty charges as banks squirrel away a stockpile of resource to cover the projected cost of people not paying their loans. The size of these provisions will be the clearest indication of the scope of the consumer crisis that’s expected in the coming quarter.

Brent crude has once again come under pressure from recession fears, which is continuing to weaken the demand profile. Weekly losses are somewhere in the region of 3.5% with prices at $94 a barrel, which is still elevated on a long-term outlook. China is the world’s biggest crude importer and demand here has been lacking, owing to the stringent zero covid policies. That said, the UK oil benchmark rallied 15% last week after OPEC+ announced cuts to production, and warnings have been issued that the persistent high prices could be what tips the global economy into recession.

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