WeekWatch

Healey eyes 'turning corner' as bonds heat up

The UK economy is ‘turning a corner’, according to UK Chancellor John Healey.

In his first major speech since becoming chancellor, and ahead of his first Budget, Healey sought to create a sense of optimism. However, rumours about thousands of job losses at Jaguar Land Rover (later confirmed) swirled before his speech, highlighting the challenges still faced.

Healey said investment, innovation and growth were high on the agenda. He noted that £1 in every £10 spent went on servicing the national debt, and that growth was key to tackling both this and the cost-of-living challenges for the public. 

Yet a jump in global government bond yields last week served as a timely reminder of the difficult decisions governments and central banks around the world currently face. 

Bonds have been under pressure for some time, however a sharp sell-off on Tuesday saw several yields hit multi-decade highs. UK 10-year gilt yields hit 5.23% on Tuesday, the highest rate since 2008. Japanese 10-year bonds broke 3% for the first time since the 1990s. There were similar stories for French and German bonds as well. US treasuries also rose notably.

Despite some calming in the second half of the week, they remained high by the time markets closed.

Circling clouds

Unfortunately for government borrowers, several factors all converged towards the end of August to put bonds under pressure.

For a start, Kevin Warsh’s speech at the Jackson Hole economic symposium hinted a rate rise might be on the way if inflation remains stubborn. Before this, the lack of forward guidance was requiring an adjustment period for fixed income investors. Markets reacted by taking a more conservative approach, effectively demanding more for their money.

Pressure on Warsh and the wider Fed to raise rates is mounting. On Friday, US payroll numbers for August outpaced expectations. 162,000 jobs were added to the economy, versus an expectation of just 55,000, while July’s estimates were lifted from a loss of 23,000 to a positive 21,000. Wage growth and unemployment rates met expectations.

With the job market looking more solid, the Federal Reserve is expected to focus more on fighting the ongoing inflationary pressures. In other words, expectations for interest rate rises increased. 

The next US CPI inflation report is due out this Friday while the Fed’s Federal Open Market Committee (FOMC) will announce its next interest rate decision on 16 September.

With the midterm elections approaching in November, any interest rate decision is likely to attract heightened political scrutiny. With fresh inflation data due, Warsh might soon find himself pulled in two directions. 

The Japan question

At the same time, expectations are mounting that the Bank of Japan will also have to increase interest rates soon, as the country grapples with inflationary pressures. 

Japanese rates can have large international implications. The so-called yen carry trade (the practice of borrowing yen on low interest rates to buy higher-yielding assets abroad) has left Japan among the largest foreign holders of US treasuries. If yields in Japan become more competitive, investors may draw down foreign holdings to buy domestic holdings instead. 

According to Greg Venizelos, fixed income strategist at St. James's Place: “The higher the Japanese yields go, the less inclined Japanese investors will be to buy non-domestic bonds, such as treasuries. So far, they've sold around 18 billion of non-domestic bonds over the last couple of quarters, which is a relatively small number. So, the issue wasn’t so much about selling so far – often they don't tend to sell to avoid crystallising losses. They may be just not reinvesting internationally.

“As long as yields are expected to keep rising in Japan, and the yen is weakening, Japanese investors may refrain from doing this. So maybe the selling hasn't really started in earnest yet. But if it does, then we could see more upward pressure in other markets.”

The Middle East and Europe

On top of this, the conflict in Iran has started to heat up again after a lull. Both sides have recently begun firing missiles and drones at one another again, adding to existing fears over oil prices.

The situation wasn’t helped by news that Europe was entering winter with some of the lowest levels of gas storage in years.

Together, these have only added to inflationary concerns that continue to cause headaches for policy makers. 

The European Central Bank is expected to lift rates later this month, as the continent grapples with rising energy prices. These expectations have added to the pressure on bonds in recent weeks.  

Homeowners and buyers warned of rising mortgage rates

Mortgage brokers are urging people buying property or remortgaging to secure deals sooner rather than later as mortgage rates are expected to climb sharply.

Last week, the UK 10-year gilt yield rose to its highest level since 2008, pushing up swap rates. Swap rates are the interest rates banks use when lending to each other in the wholesale markets. Mortgage lenders also use them as a guide when pricing their fixed rate deals for borrowers. 

The escalating conflict between Iran and the US and rising energy prices have also contributed to the increase in gilt yields.

Number of pensioners paying highest tax rate doubles in five years

Frozen tax thresholds and rising inflation have seen the number of pensioners paying the additional rate of income tax double in the last five years.

The number of pensioners paying the 45% income tax rate will increase to more than one million this year, compared with almost 500,000 in the 2021/22 tax year, according to a freedom of information request to HM Revenue & Customs (HMRC).

The higher rate of income tax has remained at 40% since 2021, as has the additional rate at 45%. It means more people get pushed into higher rates of income tax over time due to rising wages. This is known as fiscal drag.