The Old Lady of Threadneedle Street is reaching for her smelling salts this morning as the S&P 500 suffers its worst session since 2022, driven by a sudden loss of faith in Big Tech. The Nasdaq Composite plunged 3.5% in New York trading, with the so-called Magnificent Seven shedding roughly $500 billion in market capitalisation.
For the UK Treasury, this is not merely an American problem. It is a capital flight warning. When US equities tumble, global investors rush for the exits, and British gilts historically serve as the first port of call.
But this time, the calculus is different. UK government bond yields have already risen 20 basis points this week on fears that the Bank of England will be forced to keep rates higher for longer. The 10-year gilt now yields 4.
4%, a level that screams fiscal discomfort. Chancellor Jeremy Hunt must be watching the VIX index, the fear gauge, with the same anxiety as a fund manager caught short on tech. The correlation between US tech stocks and UK gilt yields is well documented.
When risk appetite evaporates, investors sell equities and buy bonds, depressing yields. But when the sell-off is triggered by inflation fears, bonds sell off too. That is the nightmare scenario.
Why are US tech stocks falling? The proximate cause is a series of underwhelming earnings reports from Alphabet and Tesla, but the underlying story is one of rising real interest rates and a hawkish Federal Reserve. The market had priced in a soft landing.
Now it fears a reacceleration of inflation. For the UK, this is a mirror. Our own inflation remains stubbornly above 4%, and the Bank of England is caught between a rock and a hard place.
The market is now pricing in only two rate cuts this year, down from four in January. That is a massive repricing. What does this mean for the UK economy?
First, mortgage rates will stay elevated. The average two-year fixed rate is already above 5.5%.
Second, the government's borrowing costs are rising. Every 10 basis point increase in gilt yields adds about 1.5 billion pounds to annual debt interest payments.
Third, sterling is weakening. The pound fell below 1.27 against the dollar overnight, making imports more expensive and adding to inflationary pressures.
Chancellor Hunt may be forced to announce further spending cuts in the autumn statement if yields continue to rise. The Office for Budget Responsibility's fiscal headroom is already wafer thin. There is a sense of deja vu.
In September 2022, the Truss mini-budget triggered a gilt market crisis. We are not there yet, but the trajectory is uncomfortable. The key level to watch is 4.
5% on the 10-year gilt. If we break above that, expect emergency commentary from the Treasury and a possible delay to the Bank's quantitative tightening programme. The irony is that the root cause of this turmoil is not in London but in Silicon Valley.
Yet the City will pay the price. As an old trader once told me: when America sneezes, London catches pneumonia.
