The Roundup – January 2025

Bond Market Bruising

October’s budget outlined the British government’s intension to fund public services and growth-driven infrastructure investments, by selling billions of pounds worth of bonds, as well as hefty increases in tax revenues. Two months later, borrowing costs spiked.

In early January 30-year UK government bond yields rose sharply to reach their highest levels since 1998, as confidence in Britain’s fiscal outlook fell. Concerns around high borrowing levels and elevated inflation (not limited to the UK) saw bond investors demand higher returns for the risk.

Also contributing to the UK’s rise in bond yields was the Bank of England’s cautiousness to easing monetary policy further. In December, the Committee voted to leave interest rates unchanged following the latest data which recorded inflation at its highest level in 7 months.

Worries that further turmoil in the bond market would warrant cuts to future spending plans were averted as markets settled towards the end of the month, following a more positive local inflation print, and added clarity around factors further afield.

However, the acceleration borrowing costs contributed to a bigger-than-expected budget deficit in December. While the anticipation of higher tax obligations saw UK companies cut pay growth expectations, and both business and consumer confidence took a hit.

In keeping with the governments focus on reigniting growth, Britain’s finance minister travelled to Davos to attend the World Economic Forum, with aims of courting international investors and promoting the UK.

Simultaneously, the head of the Competition and Markets Authority was replaced, with his lack of alignment on strategic growth cited as the reason for his exit. All eyes will be on the release of the Q4 GDP numbers, with economic activity falling for the last two quarters and estimates for the country to have contracted over the last 3 months of 2024.

Economic Strength

December’s jobs report showed the world’s largest economy added 256,000 jobs over the month, nearly 100,000 more than expected. Additionally, the unemployment rate notched down 0.1%, to 4.1%, coming in under expectations, while hourly earnings lifted. The strength of the data quickly dispelled any notion of a weakening US labour market.

Consumer sentiment for January, saw year-ahead inflation expectations lift from 2.8% to 3.3%, with long-run inflation expectations rising 0.3% to 3.3% as the US consumer showed nervousness that high inflation may return. Simultaneously, Consumer Price Index (CPI) for December rose for the third straight month, as inflation remained stubborn.

The combination of a healthy labour market and elevated inflation removed the idea that the Federal Reserve would need to urgently cut interest rates, paving a divergent path to its Central Bank peers. At their January meeting Bank officials voted to hold interest rates.

Also featuring on the Fed’s radar was the balance of the incoming Administration’s policies, widely thought to be inflationary on balance, as well as bond market sentiment - global bond markets also experienced the sell off seen in the UK.

As governments continue to tap bond markets to fund their higher spending, market participants are starting to question the consequences, particularly as the US debt pile has grown significantly since President Trump was last in power.

Perhaps bond vigilantes - traders that sell government bonds en masse with the intention to drive up borrowing costs further - may be the real check on the President’s authority.