The Garrulous Jay – Gilty Measures

The headlines emanating from the UK government bond (aka Gilt) market this week are not pretty. Yields on longer-dated Gilts such as the 10-year and 30-year have reached levels that put those seen in the aftermath of the Kwarteng mini-Budget in the shade, and take investors all the way back to the 2008 financial crisis. What, if anything does this mean?

The price of any asset is driven in part by the confidence buyers and sellers have in its value. This goes for stocks and shares, for offices and warehouses, for classic cars, for bottles of wine and for football clubs.

It is also true of debt… The price someone is prepared to pay for a debt is dictated in part by how confident buyers are that they will receive the interest promised on that IOU and their money back.

Falling debt (or bond) prices therefore reflect falling confidence in the borrower’s creditworthiness as the interest payments are fixed, so the only way to get a higher return to compensate for the perceived increase in risk is if the price drops.

So what’s the concern? In simple terms the debt market is saying Rachel Reeves is in a bit of a tight spot…

She has made promises to do some things, like spend more money on public services, and not to do other things, like increase certain taxes.

In her ideal world – which some cynics, but not I, might call LaLaLand – she can rely upon the growth in the UK economy to drive up tax revenues to meet her spending commitments. But LaLaLand is not typically reached by hiking taxes on businesses and increasing the minimum wage, both of which may also be inflationary.

If, however, the road to LaLaLand suffers from a nasty outbreak of potholing, the Chancellor has a potential get-out… Borrowing!

But herein lies the vicious circle, because if the government needs to borrow more because it’s not raising what it needs in taxes, that signals something is rotten in the state of the British economy, undermining confidence and pushing up the cost of borrowing for the government, making spending commitments harder to fund… Oops!

This in turn brings us back to confidence. Not just in the Gilt market, but in the UK as a whole. In my conversations with clients and friends over the odd glass of red over the last month, the dearth of optimism has been striking.

There remains much to recommend the UK as a place to do business: its relative political stability, its geographic position in the world, its language, its legal system, its universities, its multiculturalism, its capital markets etc. But for all these attributes to be put to good use confidence must first prevail.

Whilst UK investors – in debt or equity markets – can look overseas, many UK businesses do not have this luxury. It is therefore to be hoped that confidence returns, and the government bears much responsibility for ensuring this is the case, but so do we… If we persist in talking things down there’s a risk the prophecy of doom fulfils itself.

Happy New Year!