Insight

Interest rates are marching higher again | Weekly Market Update

25 October, 2024

Government bond yields have been rising in the last few weeks. Another way of saying the same thing is that markets now expect fewer interest rate cuts from the US Fed and the Bank of England than they did a few weeks ago. The current end-point for interest rates after the cuts are done is expected to be between 3% and 3.5%. We have effectively moved from the bottom to the top end of that range since mid-September.

I have seen explanations that this is due to the fear of increased borrowing after next week’s Labour budget. I am not so sure this is true. My reason for this is that we have seen a similar rise in the US and (to a lesser extent but from a lower base) in Europe. I don’t think the move to higher rates globally is coming from the UK.

 

Rise in 10 year

 

Instead, it is more likely that the US is the culprit. The US election is tied neck and neck in the polls. Markets (including betting markets) think Trump will out-perform his polls (as he did in 2016 and 2020) and therefore have him as the favourite. A Trump presidency should mean lower taxes and higher tariffs. Lower taxes are pro-growth, tariffs will push inflation back up. Both these will slow the rate of interest rate cuts in the US. If Trump wins I would expect bond yields in the US to move higher again and drag the UK with them. I think part of the move we have seen since September is the markets pricing an increasing likelihood of that actually happening.

The other part of the story is that growth remains strong everywhere bar Europe (and hence the lower rise in yields seen there). UK Survey data remains solidly in expansionary territory – more businesses, if asked, think things will get better over the next few months than worse – and unemployment is low. In the US the much feared slowdown in the labour market has still not arrived. I have written before about the Atlanta Fed, which takes all the latest data releases and produces a forecast for current GDP which has proven to be as accurate as anything I have seen (and better than most professional economists). This has reaccelerated again recently:

 

Evolution of Atlanta

 

With real growth above 3% and a Trump presidency potentially on its way, why cut rates at all? In the short term at least, the risks are pointing to more pain for bond markets.

What does this mean for our portfolios? If the markets are right about Trump our clients should make money on their US assets and the dollar. This will be offset by losses in fixed income and the pricing in of the impact of tariffs on international equity markets. Net net here I think we have some balance so I wouldn’t expect any major moves. But the truth is the US election remains a toss up. If polling errors are uncorrelated (and a sample size of 2 for Trump out-performance is hardly statistically significant) then we could be looking at a Harris presidency in a couple of weeks’ time. At least we don’t have long to find out! And, whatever the result, I think bond markets will continue to be much more focused on this outcome than whatever happens in the UK budget next week.

 

Chris Brown, CIO

cbrown@ipscap.com

The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.

 

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