Weekly Comment: Rising yields cause concern

Market overview – Richard Carter, Head of Fixed Interest Research

Global equities declined last week with the MSCI All Country World index returning -1.5% (-0.8% YTD). The UK 10-year gilt yield ended the week at 4.84%, up from 4.59%, and hit 4.93% on Thursday — the highest level since 2008.

United States

The US labour market closed out 2024 on a good footing, with nonfarm payrolls up considerably more than expected at 256,000 in December and the unemployment level falling slightly to 4.1%. The headline payrolls figure shows an even stronger increase than the revised 212,000 jobs added in November, which had already seen a surge compared to October when a combination of storms and strikes led to reduced payroll numbers.

All round the data points to an incredibly resilient labour market, but there are still some concerns that we could see its current momentum derailed as we move further into the year. Trump’s first few months in office could not only prove inflationary, but there is also a risk that US jobs numbers could be negatively impacted should his pledges result in a lack of workers available to fill the vacancies on offer.

US large caps fell (-1.9%) on the week to move into negative territory for 2025 ( -0.9% YTD). The index is now back around the levels it traded prior to the US election. Small caps continued their recent streak of underperformance with a larger weekly drop (-3.5%, -1.8% YTD)). Technology benchmarks (-2.3%, -0.9% YTD) posted their biggest weekly drop since November.

United Kingdom

For UK investors the focus has been on the gilt market as UK government borrowing costs reached a 16-year high. The move higher in gilt yields is largely due to global factors, but in recent days the UK has become the main area of weakness due to its unenviable mix of anaemic growth and above target inflation against a scheduled sizable increase in government borrowing. 

A fall in sterling has accompanied the rise in gilt yields in a potential warning sign that investors are losing some confidence in the UK. The pound ended the week at US$1.22, down from US$1.24, and at its lowest level in 14 months. The exchange rate was above US$1.30 the day before the US election. UK large-cap stocks were supported by the currency depreciation, adding 0.3% (1.0%) but the mid-cap space posted a notable decline (-4.1%, -4.3% YTD).

Europe ex UK

It was a more positive week for continental European stocks, as the MSCI Europe ex UK gained 1.2% (1.3% YTD). The market was supported by expectations that the European Central Bank will still lower rates this month. German (1.6%, 1.5% YTD), French (2.0%, 0.8% YTD) and Italian (2.8%, 2.6% YTD) bourses all advanced. The single currency fell closer to parity against the US dollar, ending the week at US$1.02.

Gilts in the spotlight

While there has been a global push higher in government bond yields in recent months, the gilt market is attracting unwanted attention of late due to yields hitting multi-year highs. In addition to the 10-year gilt yield reaching its highest level since 2008, the 30-year yield has reached a level not seen since the late 1990s.

The speed and scale of the moves still pales into comparison with the fallout following the 2022 “mini-budget” but recent developments have ramped up the pressure on chancellor Rachel Reeves and, if yields remain around current levels, has effectively wiped out the planned fiscal headroom.  

Rachel Reeves and Keir Starmer have both moved to reassure investors, with the former stating that the fiscal rules are “non-negotiable” and spending cuts will be made, if needed, to stay within them. However, this has provided little respite and events this week will be closely followed for signs that things are getting out of control.

Inflation data from the UK and US is due to be released on Wednesday. The UK consumer price index is expected to come in at 2.6% annually, but any acceleration in price pressures could lead to further moves higher in bond yields. The US is expected to see a rise in its equivalent reading to 2.9%, from 2.7% last time out, and the strength of the US economy — as demonstrated by last week’s job report — is clearly playing a role in the global push higher in yields.  

The Federal Reserve’s December interest rate cut could be the last we will see for some time. Recently, Fed officials have taken a considerably more cautious approach, and markets now anticipate a hold on rates until at least May. Donald Trump’s imminent inauguration and his potentially inflationary agenda of tariffs, immigration controls and personal and corporate tax cuts will likely see the Fed pause for thought at its next couple of meetings. The Fed will likely fall into ‘wait and see’ mode until at least the summer to ensure it has a better idea of how Trump’s policies are playing out.

Closer to home, this week’s gilt auctions will attract greater attention than usual with observers on the lookout for indications of the strength of demand for UK government bonds. The Bank of England is continuing with its bond-selling programme, known as quantitative tightening, for now, but if things escalate then it would not be too surprising to see policymakers pausing this.

Rachel Reeves has ruled out any imminent tax rises, stating that the budget will be an annual event with the next update due in the Autumn. In the meantime, the Office for Budget Responsibility will update its forecasts 26 March, outlining its revised view of growth. GDP readings in the second half of the year indicated a notable slowdown in economic growth and the OBR’s October forecast for 2025 of 2% looks vulnerable. However, a shortfall in GDP growth in 2025 does not necessarily directly impact fiscal policy as it may be made up later in the government’s term.

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