In this commentary, the speaker walks through the chain reaction triggered by UK Chancellor Kwasi Kwarteng’s September 2022 mini‑budget. The mini‑budget introduced £45 billion of tax cuts aimed at high earners and a £150 billion energy‑tax freeze, dramatically increasing projected government debt. The market responded immediately: the pound fell to a 37‑year low against the dollar, and UK gilt yields spiked as investors demanded higher compensation for perceived fiscal risk. The narrative then shifts to pension funds, which hold about £1.5 trillion of UK assets, half in long‑dated gilts. Rising yields forced pension funds to post additional collateral on leveraged interest‑rate swaps, prompting massive sales of gilts. This created a self‑reinforcing “death‑spiral” of falling bond prices and rising yields. The Bank of England stepped in, pledging two weeks of unlimited gilt‑buying to stabilise the market, which temporarily restored bond prices but left uncertainty about future pain. Throughout, the speaker frames the events as a high‑stakes game of dominoes, emphasizing the systemic risks of fiscal imprudence and the fragility of the UK financial system.
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So Kwasi Kwarteng has been playing a pretty high-stakes game of dominoes over the last few days, starting on Friday where he flicked the fiscal finger using his mini-budget, which ended up cascading a number of dominoes, which ended up on Wednesday with the Bank of England intervention. Now, a lot has happened in the last 5 days and a lot of dominoes have fallen. So let's explain this by playing Kwasi Kwarteng's game of dominoes. Here we go. So on Friday, Kwasi came up with this mini-budget, this fiscal event, which looked an awful lot like a fully-blown budget, but without the scrutiny. £45 billion worth of tax cuts, mainly benefiting the rich, hoping that the theory of trickle-down economics would for once actually work. Couple that with the £150 billion, uh, energy tax freeze for businesses and households, and suddenly you're looking at a massive, massive increase in government debt, which was seen by the market as pretty fiscally irresponsible. That was on Friday, and the first real domino falls on Monday. We woke up to our cornflakes on Monday morning, listened to the radio, and realized that sterling has dropped overnight, uh, and is trading at about 103, 104 against the dollar, the lowest levels in 37 years. Again, this is a massive vote of no confidence against the mini-budget and is a representation of investors, forex investors, wanting to get out of sterling because it's too risky, get out of sterling because there are safer havens, and get into— pretty much get into dollars. What this also does, as an aside, is the decrease— the devaluation of the sterling increases the cost of our imports, which which is actually pretty inflationary, especially as in the UK we have a pretty large current account deficit. So Kwasi is trying to boost economic growth, which has fallen due to inflation and increased interest rates, but actually his first act, the first domino, is actually pretty inflationary. Domino number 2. This is all where, where it all gets a little bit serious. So as a result of the budget on Friday, government short, medium, and long-term bond yields spike. So what does this mean? This means that investors from around the world are selling out of their bonds, their government bonds. Uh, a mass sale of bonds decreases the price of these bonds and increases the yield on UK government bonds. This is a massive vote of no confidence and represents the fact that investors now need to see a higher yield in order to hold government debt because they see it as more risky. The UK becomes a little bit of a basket case. We've taken on too much debt. Can we pay it back? It all gets quite concerning. Fast forward to Tuesday. And this is, again, this is the straw that encourages the Bank of England to intervene, and it's all about pension funds. Now, pension funds, uh, invest about £1.5 trillion, um, in the UK. About half of that is in long-dated government bonds. So In the short term, the increased yields and the increased interest rates have actually been beneficial for pension funds as they have to hold less assets in order to cover their future liabilities. That's fine, that's good. But actually what we care about is the other side of the story. This is where the Bank of England comes in, uh, in order to protect, uh, pension funds against, uh, yield fluctuations and to get some exposure to long-term interest rate risk, pension funds buy interest rate swaps. Now, long-term fixed rates have been rising so rapidly, as we've discussed, many of these swaps are significantly out of the money, meaning that pension funds, most of which use leverage in these swaps, uh, need to post more collateral to maintain these hedges, uh, or actually simply just sell long-dated government bonds, which leads to the kind of tipping of the last domino. In order to meet margin calls on their interest rate swaps, pension funds need to sell assets, and the first asset they turned to was their holding of long-dated government bonds. You may see where this is going. It leads to a death spiral. Selling long-term government bonds increases yields, which results in hedges being even more out of the money, requiring more collateral and the sale of more long-dated bonds, selling more gilts further increases the yield, and the spiral continues and continues and continues. And it was this negative spiral that the Bank of England was so desperate to arrest yesterday when they promised to do whatever it takes in order to calm the market. And to an extent, As we can see here, to an extent it's worked. Um, bond prices have risen, uh, yields have calmed. However, the Bank of England will only do whatever it takes for 2 weeks, so there could be a lot more pain to come.
