25 Oct 2024
UK Budget speculation continued to bubble away last week, with increased focus on employers’ National Insurance and Inheritance Tax.
Given that the government has ruled out changing the ‘Big Four’ taxes then other taxes will have to do the heavy lifting to close the £40bn black hole – it was just £22bn a few weeks ago. It will be a creditable achievement to keep taxpayers and gilt investors happy.
The economic consequences of tax cuts, big spending and sky-high tariffs would be rocketing bond yields
In the US , the Presidential election moves closer and there is still no clear favourite. Vice President Harris leads in the popular vote but the Electoral College maths may favour Donald Trump. The latter was quoted last week as saying that the word ‘tariff’ was the most beautiful one in the dictionary. It seems that investors are not taking Donald Trump at face value. In my view, the economic consequences of tax cuts, big spending and sky-high tariffs would be rocketing bond yields and plunging equities.
On the data front UK headline inflation, core inflation and services inflation all came in below consensus expectations. CPI fell from 2.2% to 1.7% and service inflation came in at 4.9%. Whilst October is likely to see a pick-up in inflation as higher energy bills impact, the headline news is good for both the government and the Bank of England. Will it be enough to get an interest rate cut in November? Yes, that looks nailed on now, but the fact that the dip in inflation was not driven by a broad reduction in underlying inflationary pressure, being influenced by volatile air fares, may not support the aggressive interest rate cut profile factored into yield curves.
UK gilts were revitalised by the inflation data with the 10-year yield falling by 15bps to just above 4%, a move reflected in real yields. In the euro area yields also dropped, following the expected 25bps rate cut. The ECB’s focus has been on weaker activity data and downside inflation surprises. So, more cuts can be expected, given the poor economic outlook. The current rate of 3.25% is still above a neutral level; our Senior Economist, Melanie Baker, thinks this is nearer 2%. Bucking the trend of lower yields, US 10-year treasury yields were broadly unchanged. Recent stronger US economic data has certainly curtailed rate expectations.
In credit markets, spreads in both investment grade and high yield trended lower. In sterling, non-gilt indices hit a spread low for the year with the yield pushed below 5%. Whilst the outlook for credit remains favourable, with spreads compensating for default risk, better opportunities are likely to arise. So I think there is a case for being long credit, but some tactical caution is currently justified.
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