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After the UK budget last week there was a fair amount of grumbling (from, I’d guess, people who didn’t vote Labour) that this was the usual tax and spend approach you’d expect from a left-leaning government. Government bond yields rose as the markets digested the fact that the UK government would need to borrow more from them. Well, this week we had pretty much the opposite result in the US: a right wing, tax-cutting Republican won comfortably. But interestingly, the bond market reaction was very similar. Less tax means more borrowing. US treasury bond yields also rose as markets digested the probability of a Republican sweep.
So whichever party gets in, the result seems to be the same: a focus on growth and a pretty relaxed attitude to high levels of government debt and borrowing. If you are in my job, then at least you know where you are. Indeed, the Trump win played pretty much as we wrote about here in June for example: Time to think about a Trump second term. US equities rose with the more growth sensitive mid-cap Russell 2000 market up the most (+7.8% for the week so far). US yields rose (and so US treasury bonds fell in price) and the dollar was stronger. That mix meant our Sterling and Euro clients have had a good week. And even our US dollar denominated clients – for whom a rising US dollar is a headwind not a tailwind – are up for the month so far.
Part of the reason this mix has been good is that central banks still remain committed to cutting interest rates. The Bank of England and the US Fed both cut by 0.25% yesterday and the market still thinks we are still on track to end up in the 3.0%-3.5% range in around 18 months’ time. Falling short term interest rates combined with pro-growth fiscal policy is a pretty good environment for equities and this has been another strong year so far.
But what are the risks to look out for next year? I am actually pretty optimistic about the economic backdrop in general. We are still quite early into the economic recovery post the Covid recession and subsequent inflation shock and, based on previous expansions, there is no reason to think there isn’t a few years more runway here.
Instead, I think the risks are once again sitting with the bond market. So far the UK Government 10 Year GILT yield is around 0.75% higher than their mid-September lows. At some point higher yields will be a problem again for asset markets. I’d suspect the latest rise is already putting some pressure on more interest rate sensitive parts of the market such as real estate and private equity backed business. For now yields still sit below their 2023 peaks (see below). Given the economic growth was steady in 2023 I don’t think we have a problem yet but, if yields continue their rise from here, this would now be my main risk for 2025.
With this in mind, we have reduced our interest exposure a little throughout the year. Looking forward into 2025, if interest rates are the risk then it makes sense to have less overall exposure to them. I suspect we will once again be looking hard at alternatives to bond markets for the next few months.
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.
