UK bonds attempt a recovery as Starmer remains in place, for now

All eyes are on the UK bond market this morning, and so far, Gilts are stabilizing. The 10-year yield is lower by 4bps, as no clear challenger to the Prime Minister’s throne has emerged. Today is the King’s Speech in Parliament, which opens Parliament and sets out the government’s legislative agenda. Reports suggest that King Charles had to ask number 10 if this was taking place today, after yesterday’s turmoil.

So close to the opening of parliament was always going to be a tough time for a coup, and at least for now, Starmer’s position looks safe, albeit highly uncomfortable. UK bonds are stahging a tentative recovery on the back of this, and yields are falling, other UK asset classes like the pound and UK stocks are stabilizing.

A big problem for the UK: the 10-year UK yield remains above 5%

The big problem for the UK economy is that the 10-year yield remains above 5%, and we expect it to hover around this level for the long term, especially If a lame duck prime minister cannot get on with delivering the economic growth he promised before the 2024 election. At 5%, government borrowing costs are rising sharply, eroding the fiscal headroom built up by the chancellor in last year’s budget. It also keeps borrowing costs for businesses high. When the cost of debt rises, businesses need to pass these costs onto consumers, so rising borrowing costs can also add to the UK’s inflation pressures, which in turn adds more upwrd pressure on bond yields.

The recent gyrations in the UK Gilt market, caused by the spike in the oil price, and aggravated by the political turmoil going on within the Labour Party, has pushed 10-year UK Gilt yields up by more than 80bps in the past 3 months. This is huge and has both economic and fiscal ramifications for the government, businesses and households.

The Gilt market saves Starmer

For now, the Gilt market may have saved the[Prime Minister, and Starmer’s position looks safe. However, markets remain sensitive to all news out of Westminster, and it is hard to see how the PM can stop another coup against him. As we have said, Streeting would be marginally more market-friendly than Burnham or Rayner taking the keys to number 10. However, we believe that this government has lost the trust of financial markets, and it is hard to see how UK Gilts can stage a meaningful recovery, or go back to tracking their G7 peers, when inflation remains high, the structure of our energy market keeps electricity prices higher than our neighbors’ and on top of this, there is a hard left faction of the Labour party calling for Starmer’s head.

No news is good news, boosts market sentiment

Elsewhere, there is a calmer tone to markets on Wednesday, as the oil price slips by more than 1%, and stocks stage a recovery after Tuesday’s sell off. ‘No news is good news’ is boosting markets, as Donald Trump turns his sights to China, where he will meet with the Chinese premier today. This means that the market does not have to digest his latest musings on the state of the ceasefire with Iran. Oil prices remains elevated and are above $106 per barrel for Brent crude. This is a dangerously high level for the global economy, and is likely to keep upside pressure on global bond yields for the medium term.  

FTSE 100 makes a comeback

The FTSE 100 is bouncing back on Wednesday and is higher by 0.7%. The top performers include the miners and some defense names, which were sold off heavily on Tuesday. The gold and silver prices are joining in the broader risk rally this morning, and the gold price is higher by 0.6% and is above $4,715 an ounce. This recovery comes even though a stronger inflation print for April has put to bed any hopes of a Fed rate cut this year. There is now a 36% chance of a Fed rate cut by mid-2027 to 3.75-4%, which suggests that the pendulum has finally swung from cuts to hikes in the US on the back of the energy price spike and the war in the Middle East.

Dimon also has his say on Labour Party turmoil

UK banks are also clawing back some of Tuesday’s losses, and Lloyds, NatWest and Barclays are all higher by more than 1.5% this morning. This comes after JP Morgan warned the government that any swing to the left of the Labour Party could threaten JP Morgan’s £10bn investment in the UK, which includes a new office in Canary Wharf. Concerns were high that the Prime Minister’s usurper could boost taxes for banking profits, to raise money for more welfare spending. Dimon highlighted the consequences to that move.

Overall, the markets are sending a clear message to the Labour Party: do not shift to the left. The tax burden in the UK is at a record high and is growing faster than anywhere else in the OECD. This is not sustainable and it is throttling the potential of the economy. If Starmer is overthrown in the coming days and weeks, then the bond market rout could get worse, and a new Labour leader could find it very hard to control the UK economy.

What to watch for on Wednesday

A chip stock sell off hit the US on Tuesday looks like it is stabilizing today, and US economic futures are also pointing to a rebound on Wednesday. Ahead today, the focus will be on news out of Westminster, updates from the US/ China summit and any developments in the Middle east. Producer price data from the US and a speech by the Bank of England’s Catherine Mann, a noted hawk, is also worth watching this afternoon.