Monthly Market Commentary - November 2024

The UK budget and US elections are two major events for financial markets in recent weeks and quite rightly dominated the news headlines. The initial market reaction has been positive for equities, with US stock benchmarks rallying to new record highs. UK gilts have not fared quite so well, as yields have risen on the expectation of additional supply to fund more government borrowing and higher inflation. That said, the yield levels on offer, in the 4%-5% region, are increasingly attractive.

Before looking in more detail at the impact the UK budget and US election will have on markets going forward, it is worth looking at the current state of play. The last 12 months have been a rewarding time for investors, with most markets providing positive returns as central banks eased monetary policy and inflation fell back.

In the 12 months to 31 October 2024, the MSCI All Country World index rose 26.3% (all returns in sterling, unless stated otherwise). US equities have been the standout performer, rallying 30.6% but there has also been pleasing returns from the MSCI UK (16.0%) and MSCI Europe ex UK (16.7%). Although the environment has not been the most conducive to fixed income investments — central banks have generally pursued a slower and shallower rate-cutting path than previously expected — the iBoxx gilts index has still returned 5.5%. Among most major markets, the only significant faller in the past 12 months has been Brent crude oil (-16.3%), which in itself is a helpful factor in easing inflationary concerns.

While the past 12 months contained a number of unexpected developments, the macroeconomic paradigm has been fairly consistent. Central banks have been lowering interest rates, inflation has continued to fall back towards target and economic activity continues to hold up fairly well, on the whole. This backdrop has supported better-than-expected corporate earnings and underpinned the strong stock market performance. The question now for investors is whether recent developments significantly alter this dynamic and, if so, in what fashion.

The longer-term impact of the plans remains uncertain and Rachel Reeves, UK chancellor, faces a delicate balancing act with minimal fiscal headroom. The change to the fiscal rules to allow for greater borrowing has received IMF support, but with bond yields rising significantly in recent years the hurdle rate for productive investment has also moved substantially higher.

It’s hard to see the budget as pro-growth when the majority of the additional tax revenue will come from a levy on the cost of employment and seemingly front-loaded government spending plans, with substantial increases up to 2026 fizzling out in subsequent years to make the books balance by the end of the government’s term. The overall tax burden is scheduled to rise to its highest level on record by the end of the decade, reaching 38% of GDP.

A closer look at the sector-by-sector impact of the UK budget can be found here.

Although markets were forewarned of many of the most important tax changes, there was a notable reaction in bonds as yields pushed higher, seemingly on the prospect of higher-than-expected borrowing. That being said, the reaction to the largest fiscal loosening in a generation was measured and a far cry from the pandemonium that ensued just over two years prior following Liz Truss’s “mini” budget.

Although UK gilt yields have moved up close to their highest levels since the 2008 global financial crisis, this is almost entirely due to factors pre-dating the budget. A comparison to the US treasury market reveals that most of the recent gilt moves are not reflective of UK-specific factors.

The UK 10-year gilt yield currently has a spread of around 10 basis points over the US equivalent, a similar level to that seen during most of September. While this spread has risen from a low of -40 basis points in April (US 10-year yielding 40 basis points over 10-year gilts) it is still well below the +65 basis point level seen in July 2023. This suggests that talk of a lingering “risk premium” in UK government bonds is misplaced.

Source: Bloomberg