Bond Markets Flash Danger Signals

The general perception has been that falling interest rates and lower bond yields would support asset prices in 2025. This is conspicuously not happening. US 10-year bond yields are approaching levels last seen during the 2007-09 financial crisis.

Currency markets are feeling the strain.

The UK political situation is finely balanced with confidence draining away that Kier Starmer and Rachel Reeves know what they are doing. Sir Keir Starmer is more unpopular than any incoming prime minister in over 40 years.

He appears to be in the trade unions’ pocket, which is not a good place to be when decisive action is needed to cut public spending.

He is also threatened by a popular alternative in Nigel Farage who leads the betting to become the next prime minister and whose party, Reform UK, is attracting serious funding. It may be too early but there is a danger that a good result for Reform in the May local elections could change the UK political landscape overnight, give runaway momentum to the new party and put both traditional parties under severe pressure.

Starmer looks like a man on the wrong side of history as countries worldwide lose faith in the old big state, and high tax solutions and even Kemi Badenoch may find it hard to reposition a Tory party so committed to the middle ground.

I will almost certainly vote Reform again in the next election so it appears the Tories have lost me for good and I may even stir myself to vote for the first time in local elections. I want to see serious change in this country and I don’t expect Labour or the Tories to deliver it.

In North America, the departure of Justin Trudeau signals another nail in the old big state, high tax consensus as does the election of Donald Trump as the next US president. The scary thing for markets is that Trump is such a wild card, likely to cut taxes without bothering too much about balancing the US budget.

If Musk, an intriguing loose cannon on the global political stage, can cut trillions off the US budget all might be fine but bond markets seem sceptical.

The UK bond market leaves little scope for manoeuvre for Starmer and Reeves.

Ten-year gilt yields are heading higher in what looks like a breakout. It seems incredible but the government may be hitting limits on its ability to borrow, which will be a frightening wake-up call for an untried government. Rising bond yields mean that refinancing the existing government debt as it falls due becomes more expensive in a vicious circle of disaster.

Decisive action will be needed but Starmer, Reeves, Raynor & Co. seem unlikely and maybe unable to provide it. Voters may follow me in turning to more drastic solutions.

Farage has his own credibility problems but at least he is thinking on the right lines.

Carl Emmerson, deputy director at the Institute for Fiscal Studies, said: “Reform UK proposes tax cuts that it estimates would cost nearly £90bn per year, and spending increases of £50bn per year. It claims that it would pay for these through £150bn per year of reductions in other spending, covering public services, debt interest and working-age benefits.

This would represent a big cut to the size of the state. Regardless of the pros and cons of shrinking the state, or of any of their specific measures, the package as a whole is problematic. Spending reductions would save less than stated, and the tax cuts would cost more than stated, by a margin of tens of billions of pounds per year. Meanwhile the spending increases would cost more than stated if they are to achieve their objectives.

A reduction in tax of £90bn a year, while sizeable, would still see tax revenues higher as a share of the economy than in 2019–20. But in reality the package of tax cuts proposed would, if and when fully implemented, cost tens of billions of pounds a year more than that. For example, Reform UK plans to cut the rate of corporation tax from 25pc to 20pc immediately, and then to 15pc in year 3 of the parliament. The manifesto costing of £18bn a year over the course of the next parliament for all its business tax cuts is less than half of what official estimates suggest the long-run cost of just this cut in the corporation tax rate to 15pc would be.

Of the proposed spending increases, the largest is for the NHS (£17bn per year). However, this would not be nearly enough to meet Reform’s incredibly ambitious commitment to eliminate waiting lists within two years. Eliminating the waiting list entirely is a feat that has not been achieved in the history of the NHS and seems near impossible within two years.

The cost-saving measures would save less than set out. There is a respectable argument for changing the extent to which the Bank of England pays interest to commercial banks, and indeed some other central banks don’t pay interest on all the reserves they hold. But whether a good idea or not, it would raise a lot less than £35bn per year. Reform also propose to reduce “wasteful” spending by £50bn per year across all government departments, quangos and commissions. But saving this sum would require much more than a crackdown on waste; it would almost certainly require substantial cuts to the quantity or quality of public services.

Even with the extremely optimistic assumptions about how much economic growth would increase, the sums in this manifesto do not add up. Whilst Reform’s manifesto gives a clear sense of priority, a government could only implement parts of this package, or would need to find other ways to help pay for it, which would mean losers not specified.”

Institute for Fiscal Studies (IFS)

I can see why the IFS is pessimistic but maybe they are too cautious. Supply side economics may come to the rescue. I have just read a long study of supply side economics which vividly highlights the idea that if you put 20 economists in a room they will fight like ferrets in a sack.

I prefer the common sense view that cutting taxes as part of a massive shift from state to private spending will stimulate economic growth. The initial effect may be to increase the government deficit but over time as the economy expands tax revenues should rise and reduce the deficit. Higher supply of goods and services should also restrain inflation.

Many economists (ferrets) don’t agreed but then they never do. Some lean left, some lean right like the rest of us. What we can say with some conviction is that the present approach, ever higher taxes and an ever larger state, is not working.

Bottom line I fear a credit crunch may be coming and this will bring in its train an unpredictable political upheaval.