The markets continued their losing streak. In fact, towards the end of the month, the Nifty closed lower on seven consecutive days. And then there was the last day of the month; when the markets gained 2% in just one day.
Much of the last two days were similar for markets across the globe though, thanks to what’s happening in England!
What happened in England?
1. England recently got a new Prime Minister - Liz Truss. Soon after coming into office on September 6, 2022, last week, she announced her mini-budget of sorts. The key highlights of the budget:
A massive tax cut
Subsidising energy bills
While this sounds great, it only sounds great in an expansionary environment. When inflation is on the rise, an expansionary policy is dangerous. It further fuels inflation.
2. Of course, the markets reacted poorly to this plan, and sent bond prices in the UK spiralling down. This is what happened after:
Sent yields high up, making it expensive for the government to fund its increasing deficit
Pension funds in the UK had pledged their UK government bonds as collateral to buy ‘liability driven investment’ schemes - these provide protection against sharp interest rate movements.
But with the bond prices going lower, additional collateral was required, which would force pension funds to sell bonds at low prices, further pushing prices lower, and further increasing collateral requirements - basically a downward spiral, and a financial crisis
This spooked markets globally and sent equities into sharp dips.
The Bank of England had to then intervene. It said it would buy long-dated UK government bonds to restore market conditions. In short, pump liquidity into the markets, and further fuel inflation.
But look at the choices it had - an immediate financial crisis versus inflation, which can be tackled using gradual rate hikes by the central bank. It chose the latter.
Just the fact that quick action could avoid a financial crisis sent a positive message around the world, sending equity markets higher across.
And that’s the story of the last day of the month, where Nifty 50 gained 2%. The bittersweet pill that the Bank of England took to avoid a financial crisis.
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