London Calling: How Britain’s Folly Affects You

The British pound has plunged, currencies are in turmoil, and global equity markets are on a roller coaster. The new Tory government bears much of the blame and yes, it all affects your portfolio.

The multiple crises unfolding in Britain have a strong international dimension. In a minute, I’ll explain the country’s travails and what they mean for investors. But first, let’s examine the big news in our country: the latest inflation data.

On Friday, the U.S. Bureau of Economic Analysis (BEA) released its August reading of the U.S. personal consumption expenditures price index (PCE), the Federal Reserve’s preferred gauge of inflation.

Inflation came in hotter than expected. Again.

The PCE climbed 0.3% month-over-month in August, after a 0.1% decrease in July. Prices for goods decreased 0.3% and prices for services increased 0.6%. Food prices increased 0.8% and energy prices decreased 5.5%. The annual rate slowed to 6.2% from 6.4% in July.

Excluding food and energy, the “core” PCE price index increased 0.6% month-over-month and 4.9% annually, well above the Fed’s 2% target rate.

Personal income increased $71.6 billion, or 0.3% at a monthly rate, while consumer spending increased $67.5 billion, or 0.4%, in August.

The major U.S. stock market indices closed sharply down on Friday, as follows: the Dow Jones Industrial Average -1.71%; the S&P 500 -1.51%; the tech-heavy NASDAQ -1.51%; and the small-cap Russell 2000 -0.61%. A key factor weighing on stocks was Friday’s PCE data. Stubbornly high inflation will likely prompt the Fed to keep a heavy foot on the monetary brake for at least the rest of 2022.

After a bout of optimism this summer that drove a powerful rally, investors are again fretting about global economic contraction, energy shortages in Europe, and the worsening Russia-Ukraine war.

The major U.S. averages on Friday wrapped up a week, month, and quarter that were all negative. The averages fell for the third consecutive quarter.

And now for something completely different…

As if there hasn’t been enough geopolitical tumult, a new source of overseas worry has emerged: Britain. Events in that country this week have resembled a Monty Python sketch.

During its apogee in the late 19th and early 20th centuries, the British Empire reached a territorial size larger than that of any other empire in history. Britain was once referred to as “the empire on which the sun never sets.”

But someone forgot to tell the United Kingdom that its empire is largely gone. Rising nationalism, detestation of immigrants, and the lingering pride of British “exceptionalism” drove this island nation to an act of self-sabotage known as Brexit.

Now, the sun seems to be setting on the country’s economy. Britain had been the world’s fifth-largest economy, until this year, when it was overtaken by its former colony India.

A major factor for Britain’s economic downgrade was its exit from the European Union, which complicated and dampened trade with the Continent. In addition, the pandemic and war in Eastern Europe have spawned an energy crisis in Britain. The country also faces a sharply slowing economy combined with spiking inflation. The British Chambers of Commerce currently expects U.K. inflation to reach 14% in Q4 2022, the fastest pace in 40 years.

This week, the British pound sank to near parity with the U.S. dollar, its lowest recorded point. The culprit is a fiscal policy that’s come to be known (derisively) as “Trussonomics.”

Tory Prime Minister Liz Truss, newly installed at 10 Downing Street and eager to emulate her hero Maggie Thatcher, presented a supply-side blueprint for slashing taxes, despite hot inflation and rapidly rising interest rates. The plan also provides subsidies for homeowners struggling with high energy costs.

Economists warn that the plan’s new spending and unfunded tax cuts will increase inflation by stoking consumer spending, and burden the government with greater (and increasingly more expensive) debt. The measures conflict with overall attempts by the U.K.’s central bank, the Bank of England (BoE), to combat inflation by tightening monetary policy.

The government’s plan has been fiercely condemned by all sides of the political spectrum, as well as by the International Monetary Fund. The most widely decried aspect of the plan is its reduction by five percentage points of the country’s top income tax rate, which has led to concerns of bigger deficits and widening social inequality.

The influential economist Dario Perkins, managing director at economic and investment research firm TS Lombard, went so far as to call the plan “moronic.” The Truss government’s poll numbers have crashed into the basement and the Labor party smells blood.

This tweet, posted Thursday by Perkins, pointedly sums up the global stakes:

Due to the Truss plan, British government bond yields soared in tandem with the plummeting pound, prompting the BoE to resurrect its bond-buying program in an emergency move Wednesday to stabilize financial markets and shore up pension funds. It was the BoE’s quick action that lifted global equities out of the trough Wednesday, although they fell again on Thursday.

Rue Britannia…

The drama in Britain has prompted global investors to flee risk assets, in fear that Britain’s woes will trigger financial contagion. They’ve flocked to the safe haven of the U.S. dollar, driving up the greenback’s value versus other major currencies. The dollar currently hovers at a 20-year high.

When the greenback is persistently strong, it soaks up liquidity, at the expense of other assets. As I’ve recently written, a strong U.S. dollar has its pros and cons.

Read This Story: Why a “Strong” U.S. Dollar Is Both a Blessing and a Curse

The dollar still plays a pivotal role in the global economy. The dollar is the world’s reserve currency and many vital commodities, notably crude oil, are priced in dollars. A rising dollar often spawns financial problems for other nations, especially emerging markets, that can come back to haunt the U.S.

Meanwhile, back here in the U.S., the labor market shows no sign of cooling off. On Thursday, weekly initial jobless claims came in at 193,000 for the latest week, dramatically lower than the estimated 216,000. The labor market has been a positive in the economy and its strength is garnering close scrutiny from the Fed.

A robust jobs market supports consumer spending and rising wages, a dynamic that further justifies the Fed’s aggressively hawkish stance to quell inflation. Whether it’s here in this country, or across the pond on the international stage, the markets will continue to experience extreme volatility.

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John Persinos is the editorial director of Investing Daily.

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