With US markets closed for Thanksgiving, UK and European stock indices are mostly drifting a touch lower this morning. The focus remains on the postmortem of the UK budget. UK bond yields are higher this morning, and Gilts are underperforming European peers, after their sharp decline on Wednesday. The pound is the worst performing currency in the G10 FX space on Thursday, as it gives back some of Wednesday’s gains. For now, GBP/USD remains above $1.32, and it is still the third best performing currency in the G10 FX space so far this week.
Bond market’s nod of approval for UK Budget
Overall, the bond market gave a nod of approval to Rachel Reeves’ budget on Wednesday. The £22bn fiscal buffer is enough to placate bond markets who are willing to look through increased borrowing in the coming years compared to the OBR’s last estimate. The fiscal risk premium is being eroded from UK yields, even if Gilts are underperforming today. The 30-year UK yield is approaching the 5.2% level, as the pre-budget angst that pushed up yields in recent weeks reverses course. However, UK long end Gilt yields are still more than 50bps higher than they were a year ago. If the fiscal risk premium is lower after this budget due to a bigger fiscal buffer and the relative political stability compared to the last few months, then we should see UK Gilts continue to outperform and yields continue to fall.
Fiscal risk premium reduced, but this may not weigh on Sterling
We do not think that this will mean a sharp decline in sterling. As you can see in the chart below, which shows GBP/USD and the 30-year Gilt yield, which have been normalized to show how they move together, sterling has trended lower as long term yields rose during the summer. In recent days, GBP/USD and Gilt yields have been moving in opposite directions. Thus, if yields are falling because of a reduced fiscal premium, this could boost the pound back to £1.35 highs vs, the USD.
Chart 1: GBP/USD and 30-year Gilt yield, normalized to show how they move together
Elsewhere, although US markets are closed for the Thanksgiving holiday, the mood music for markets has changed in recent days as we move through November. Month to date, the S&P 500 is down 0.4%, the Nasdaq is down 2.15%, the Eurostoxx index is down 0.16% and the FTSE 100 is down 0.48%. However, there has been a decent recovery after sharp losses at the start of this month, as global indices have picked up sharply in the past week. Over the last 5 days, the S&P 500 is higher by 2.5%, the Nasdaq is higher by 2.8%, and the FTSE 100 is up by 1.5%.
Three powerful drivers for markets
There are three drivers that have calmed markets in the last couple of weeks: 1, increasing chances of rate cuts from the Fed and the Bank of England, 2, a rejuvenated AI trade led by Google, its share price is higher by 20% in the past month as well as strong gains for the broader market. Lastly, relative political stability now that the US Federal government is back open.
Wider market breadth is good news for stocks
There is now an 80% chance of a Fed rate cut next month, and a 90% chance of a cut by the Bank of England, so we are expecting looser monetary policy in the coming weeks. The 20% gain in Alphabet’s shares could pull back, as this is a big move. However, even in the face of a potential pull back in Alphabet’s share price, and Nvidia’s 5% decline in a month, the AI trade is not the only stock market narrative as we move towards the final month of the year. The biggest gainers on the S&P 500 in the past week, include DR Horton, Black & Decker, Delta Airlines and Ralph Lauren, and the equal weighted S&P 500 has outperformed the market cap weighted S&P 500 since the middle of November. This is a big shift, and wider stock market breadth in the US is positive for stocks and investors.