UK Gilts are in recovery mode as we wait for Burnham’s speech

Key takeaways

• European stock indices rise as Brent crude pulls back from the 100 USD level.
• UK Gilt yields fall sharply as markets anticipate growth measures from Andy Burnham.
• UK diesel prices hit record highs amid fears of an upcoming US export ban.
• GBP/USD remains resilient above 1.3230 ahead of key political speeches and US data.

Stock indices in Europe are pushing higher on Tuesday, although the oil price is still rising. The Brent crude continuous contract is up by 1% this morning, but it has backed away from the key $100 level that it reached earlier, which is boosting the market mood. Sovereign bond yields are in recovery mode, and are giving up some of Monday’s gains, led by UK Gilts. Overall, markets are in wait-and-see mode, as we lead up to some key events including Andy Burnham’s Labour Party conference speech later today, and a slew of US data releases that could determine when the Federal Reserve will next hike interest rates. The UK Gilt market is worth watching closely today. There is growing expectation that Burnham could announce some radical measures to boost growth and tackle the thorny political issues that are needed to get the UK’s public finances back under control. This includes:

• Welfare reform, not quite spending cuts, but a plan to reduce benefits for young people and get them into work instead.
• Pension reform: the PM could use this speech to dismantle the pensions triple lock that has been in place for 16 years. There have been growing arguments about how sustainable this is, and Burnham could plan to scrap or downgrade the triple lock to fund an NHS-Style social care system that would benefit pensioners and help them keep their homes even if they need care down the line.
• Plans to assert more public control over key utilities like water, although we doubt that he will call for a full nationalisation.

UK Gilts are outperforming this morning, and yields are falling sharply, the 2-year yield is lower by 13bps and the 10-year is also lower, although losses have eased as we have moved through the morning. This suggests that the market is willing to give Burnham the benefit of the doubt in the lead up to this Budget, although the bond market’s patience is notoriously thin. We do not think that Burnham will delve into too much detail in this speech, rather he will lay out his framework for the next election. If he touts higher taxes as a way to fund social care on top of the NHS, we think that this will be badly received by the bond market, as the tax take is already at a record high, and the NHS is already an extremely expensive service to provide.

Instead, the market will be looking for spending cuts to fund any new policy promises.

Can Burnham actually push through welfare reform?

Kier Starmer never recovered from his attempt at welfare cuts, including means testing winter fuel payments. At this stage, it is unclear that Burnham could get his party on side if he decides to scrap the triple lock. Added to this, it may not be the panacea that some think it will be. It is unclear when savings would be made, it would likely take many years, and the social care system could end up being much more expensive than the £18bn a year Burnham touted at the weekend.

Thus, pensions are the tip of the iceberg, and there is plenty more fiscal work to do in the UK, and the boost for Gilts may not last for long. Even so, the recovery in UK Gilts is still noteworthy, and could be a sign of two things: 1, the fact that the UK is trying to tackle difficult public spending issues is positive for the Gilt market, and is very different compared to elsewhere, and 2, The Gilt market sell off had reached such an extreme that prices were looking attractive.

Diesel export ban in focus

Although today’s price action is positive for the UK, the country remains in tricky fiscal waters. It is set to pay the highest yield at its upcoming 10-year debt auction since 1999. UK Gilt yields could also reverse course and start rising again if the UK cannot secure an exemption from an expected US ban on diesel exports. The UK imports nearly 20% of diesel from the US, so ministers are hoping that a lobbying effort will work and the UK will receive a much-needed exemption. Diesel prices hit a record at the start of this week, and could put more pressure on inflation and Gilt yields if it rises further.

Sterling drifts into Burnham speech

GBP/USD is drifting into Burnham’s speech, and remains above $1.3230. Over the past week, the pound has found its feet, and is one of the more resilient G7 currencies, although it’s still struggling against a strong dollar. There are mumblings in the market that Treasuries have sold off too sharply and are now detached from fundamentals. If Treasury yields fall then we could see the dollar start to give back some recent gains, after rising more than 2% on a broad basis in the past month. Overall, the focus today will be on the global sovereign bond market, after yields surged on Monday. All eyes are on whether Andy Burnham can offer soothing words to the bond market, and UK yields can continue to see a narrowing differential with US Treasury yields.

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