A Cost-of-Living Government – Markets ask, “How Will This be Funded?”
Conscious that Keir Starmer was perceived to have wasted his early days in Downing Street, Andy Burnham has started his premiership by introducing policies from the start. He is aiming to cut costs for people's lives, with a VAT reduction on domestic energy supplies and a reduction in the cap on local bus fares from £3 to £2. On the scale of government expenditure, these schemes are small and seem aimed at cementing his persona as someone who helps those who are most affected by the heightened cost of living.
Despite their moderate impact on the nation's finances, he has attempted to set out how each policy will be funded. This is an attempt to keep investors onside, who have been anxious over the arrival of a Prime Minister who previously said that “we’ve got to get beyond this thing of being in hock to the bond markets”. The appointment of John Healey as Chancellor also appears to be an attempt to keep the ‘bond vigilantes’ at bay. Ed Miliband and Shabana Mahmood had previously been seen as the front runners to control the nation's purse strings, but with the former's net zero focus viewed as anti-business and the latter's lack of financial experience, Burnham hopes Healey will be viewed as a safe pair of hands given his previous Treasury experience during the Blair/Brown years.
The challenge for Healey will be how much spending he allows for the Ministry of Defence, given his previous resignation from that post after being awarded what he viewed as an insufficient budget by his predecessor in Number 11, Rachel Reeves.
Bond markets are jittery in these early days of the Burnham government. While he has pledged to stick to many aspects of the Starmer/Reeves manifesto and fiscal rules in an attempt to convince markets that he will not excessively borrow, investors will be nervous about his desire to roll back the Thatcherite neoliberalism of the last 40 years. Should this lead him to deliver stronger and more broadly shared economic growth across the whole country, as he has promised, then markets will reward him. However, should this simply lead to further spending funded through growth-sapping taxes or greater borrowing, then expect UK government bonds to fall in value and interest rates to rise.
Iran War
The ceasefire in the US-Iran war has collapsed and conflict is once again active in the Middle East. The Strait of Hormuz is effectively closed once again and oil prices have increased, with the price of a barrel currently around $90. At the start of July, the price was around $70. This is a moderate increase so far and reflects the market assumption that the latest aggression is part of a negotiation process that will ultimately lead to a settlement.
Both sides still have strong incentives to end the war, but with Iran recognising that control over the Strait is its strongest leverage, and that the US had tried to weaken this by encouraging shipping traffic to pass on the Omani side of the waterway, it appears Tehran is willing to endure further assaults in the short term. This comes in retaliation for attacks on vessels following the US-designated route.
The resumption of hostilities has hurt investors, and has been a leading factor in the recent rise in government bond yields (alongside UK-specific concerns over the Burnham government). More pain could come if oil prices continue to rise. The peak so far in this crisis has been around $110 a barrel, and Goldman Sachs has warned that prices could spike to $120 if the Strait remains disrupted towards the end of this year. If this scenario were to materialise, then we should expect further losses in bonds and a significant headwind for equities.
In the UK, the latest inflation reading has just been released at a slightly lower-than-expected 2.6%. This is good news, but it is likely to be short-lived unless the oil price drops from its current level.
AI Volatility Continues
Asian chipmakers had been experiencing incredible gains over recent months, as investors were increasingly looking for companies involved in the AI boom but with more compelling valuations than the US ‘hyperscalers’, who are increasingly being questioned over the financial sustainability of their huge data centre investments.
The likes of TSMC, SK Hynix and Samsung Electronics fit this mould, given the huge order books they have to supply semiconductor chips to US tech giants, and as such their share prices have risen sharply.
Over recent weeks, however, these stocks have experienced losses. Given the speed of the previous gains, a retrenchment is unsurprising, and the longer-term opportunities remain.
In the investment portfolios managed by Future Money, there is exposure to these stocks through Asian equity allocations. These positions have been trimmed given the scale of gains in recent months and the potential for further downside in the short term, but these reduced positions are being maintained in the expectation of continued growth over the medium term, with position sizes being continuously reviewed as opportunities evolve.