Falling yields take edge off UK borrowing costs but City’s eyes are on Rishi Sunak
The rebound seen over the course of the last couple of days appears to be being driven by a sharp fall in bond yields, at least in European markets with the sharp drop in UK gilt yields marking the unwind in premium that we saw in the aftermath of the market turmoil post the UK mini budget.
Markets are hoping that the coronation of Rishi Sunak as the next UK Prime Minister will help draw a line under the events of recent days, as the new PM elect warned his party that they needed to unite or die.
“This may prove to be a tall order, given the Tories propensity for fratricide over the years,” said Michael Hewson, Chief Market Analyst at CMC Markets UK, this morning.
“Given recent events it’s likely that the old divisions may well reassert themselves in the coming days, as things settle down, or if the polls don’t improve.”
Michael Hewson
“However given recent events it would be quite something to see an immediate rebound in the government’s political fortunes,” Hewson noted.
The fall in UK gilt yields does suggest one thing and that is we will probably see a budget delivered next week and all the indications are it will be delivered by Jeremy Hunt, the existing Chancellor of the Exchequer.
“It would be highly unsettling for markets if Hunt was removed this close to Monday’s budget, however given the Tories recent propensity for shooting themselves in the face, anything is possible,” Hewson said.
Grim outlook
While gilt yields fell back, the pound struggled for gains, largely on the basis that the economic outlook for the UK economy remains grim, and any new measures that are announced in next week’s budget are unlikely to improve that.
Nonetheless, Hewson pointed out that UK 2-year yields are now back at levels last seen on the 22nd September just prior to the mini-budget, after posting the biggest daily drop in yields in 30 years.
“That said, the outlook growth in Europe looks little better after the latest flash PMI numbers showed economic activity contracted for the fourth month in a row, with manufacturing getting hit the hardest, although services fared little better.”
“Energy intensive industries fared the worst on the back of surging energy prices, as the cost of reliance on cheap Russian gas became ever starker.”
Michael Hewson
US markets also underwent another positive session in what is set to be a big week for tech earnings, starting with Microsoft as well as Google owner Alphabet later today.
“The rebound in US markets appears to be being driven by an expectation that we may be close to a pause in the current pace of Fed rate rises, while US Treasury Secretary Janet Yellen said that she can’t rule out the risk of a recession,” Hewson explained.
“That said, the continued resilience in US treasury yields suggests that bond markets have their doubts about a pause and that the Fed will probably push its luck until something snaps,” he noted.
With Federal Reserve officials now officially in a quiet period in the lead-up to next week’s meeting, there is little prospect of any sort of pushback on this belief.
“Let’s hope that markets aren’t getting ahead of themselves and indulging in a spot of wishful thinking,” Hewson concluded.