Weekly comment: Budget impacts, election dynamics, and rate cuts

Market overview – Richard Carter, Head of Fixed Interest Research

Last week, the MSCI All Country World Index retreated by -1.2%, marking a -2.2% decline for October but still up 16.9% year-to-date.

The United States:

In the US, large caps fell by -1.4% (21.5% YTD) amid a busy week for corporate earnings. Despite hitting record intraday highs midweek, tech benchmarks ended down -1.5% (22.2% YTD). Growth stocks underperformed value stocks, influenced by cautious earnings report from major tech companies and members of the magnificent seven Meta and Microsoft. Small caps fared better, gaining 0.1% (10.2% YTD).

The United Kingdom:

Influenced by last week’s Autumn Budget, UK large caps declined by -0.9% (9.1% YTD), while mid cap dropped -1.6% (7.0% YTD). The British pound weakened against the US dollar, ending the week at US$1.29.

Europe excluding the UK:

Concerns over Middle Eastern conflicts and tempered expectations for ECB rate cuts weighed on sentiment in European markets, with the MSCI Europe ex UK Index ending the week down -1.6% (8.1% YTD). Major large caps in Germany (-1.1%), France (-1.2%), and Italy (-0.3%) saw declines. The euro remained stable against the US dollar at €1.08.

Labour's budget bond response

In the first Labour budget in 14 years, UK Chancellor Rachel Reeves announced £70 billion in extra spending over the next five years, funded by £40 billion in tax increases and £32 billion in additional borrowing. The Office for Budget Responsibility warned that higher taxes could dampen long-term growth although it will provide a near-term boost, forecasting economic growth of just over 1% this year and 2% next year.

Reeves’ inaugural budget as chancellor saw an adverse reaction in the bond market, although the scale of the declines was far more contained than after the mini budget of 2022. Slightly higher than expected levels of gilt issuance going forward saw an initial falling in bond yields erased and then reversed. While yields did rise materially the day after, this was part of a broader trend of rising government bond yields globally.

The 10-year gilt yield rose 21 basis points on the week to close at 4.44%, briefly moving above the 4.50% level to trade at its highest level of the year. Although there was a notable increase in the premium for UK bonds, the US 10-year yield (+15 basis points) and German 10-year yield (+11 basis points) show that this accounts for only a portion of the move.

For a sector-by-sector breakdown of last week’s Autumn Budget, click here.

Rate cut expected from the BoE

The Bank of England (BoE) is expected to vote for its second interest rate cut this year despite predictions that Rachel Reeves’ budget will boost near-term demand, as the UK central bank focuses on a longer-term picture of slowing inflation.

The BoE’s Monetary Policy Committee (MPC) will announce its latest interest rate decision on Thursday, with economists forecasting a quarter-point reduction in the benchmark rate to 4.75%. Traders on Friday were putting a near 90% probability on a second reduction after August’s cut, the first in more than four years.

Us economic reports ahead of the US election

Last week’s US economic reports provided a mixed picture of the labour market, which is likely to influence voter sentiment as the country heads into election week.

The Labor Department reported that job openings fell to 7.44 million in September, the lowest level since January 2021. This decline suggests that the labour market may be cooling, which could be seen as a concern for voters.

The labor department’s nonfarm payroll report came in much worse than expected, with only 12,000 jobs added in October, the lowest number since December 2020. While there were mitigating circumstances for the weakness — the Boeing workers’ strike and weather-related disruptions — the data does potentially change the picture for US employment. After soft July and August readings a blowout September print seemed to suggest the weakness was just a blip, but a subsequent soft report indicates that maybe the September reading was the outlier. There were also notable downwards revisions in the latest report to prior reading.

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