UK increases fears of contagion risk across markets

Intense market volatility in the UK escalated recession risks and global contagion fears. The gold market is one clear example, as it is cautiously observing the developments as prices rise from 2.5-year lows.

UK market’s decline continues one day after the BoE intervened in the gilt market via an emergency bond-buying program that promised unlimited purchases of long-dated bonds. On Thursday, Liz Truss defended her plan of 45 billion pounds for unfunded tax cuts. “I’m very clear the government has done the right thing,” she said adding “this is the right plan.”

A massive tax cut during an inflationary time has led to criticisms from the US and the International Monetary Fund. Joe Biden’s administration is working with the IMF to influence Truss to dial back her policies, citing concern over volatility in the financial markets and spillover effects to the broader economy. Earlier this week, the IMF urged The UK to “reconsider” its tax measures.

Washington is concerned about the market spillovers stemming from the UK tax plan. Markets have calmed after the Bank of England’s emergency bond-buying plan was announced. This is similar in spirit to what the Fed did in summer 2019.

Truss is facing severe criticism as well, with former BOE Governor Mark Carney warning against the tax plan and stating that it is “undercutting” the nation’s economic institutions.

The message of financial markets is that there is a limit to unfunded spending and unfunded tax cuts in this environment. The price of such measures is much higher borrowing costs for the government and for mortgage holders and borrowers up and down the country.

As a result of the situation in the UK, the BoE’s tightening expectations had elevated. There are now expectations that the BOE could hike by 155 basis points at its November meeting.


Gold’s reaction to the market chaos has been positive so far. The precious metal rallied nearly $50 from 2.5-year lows Wednesday. And Thursday, it was able to hold the $1,650 an ounce level amid a meltdown in the US equities and a small drop in the US dollar index and Treasury yields. At the time of writing, gold is trading at $1663 per ounce.

Gold prices welcomed the BOE’s dramatic intervention that avoided an imminent gilts-crash and sent global bond yields sharply lower. This was somewhat expected and serves as a reminder that gold will do just fine once the global bond market selloff is over.

Global recession fears will persist as the main theme for the rest of the year, and that should limit how far global bond yields end up going. Gold’s two-year low might be the bottom, if not, it should be very close to it.