BOND MARKETS LOOK TO INFLATION FOLLOWING A SLIGHTLY UNDERWHELMING BUDGET

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Data Sourced from FE Analytics, and Bloomberg Finance LP

BOND MARKETS LOOK TO INFLATION FOLLOWING A SLIGHTLY UNDERWHELMING BUDGET

This week we received the first Labour budget in 14 years and the first ever delivered by a female chancellor. But, despite government efforts to hype up the need for a difficult budget, that was about as radical as things got. Yes, taxation has increased on businesses and the wealthy, but this was nothing like as bad as had been predicted. Government spending has increased, but having laid the groundwork the chancellor has missed a once in a generation opportunity to do something truly different.

Government borrowing is increasing, but not by much as previously feared. Bond yields have risen since the budget as markets appear a little more nervous of budgets since the Truss/Kwarteng shock of two years ago. But, despite headlines suggesting otherwise, the shift in bond yields has more to do with a fear of inflation than concerns about additional government borrowing. There was nothing in this budget to alter the Bank of England’s view of inflation and we only have to wait until next Wednesday to get an indication of whether bond markets have overreacted.

UK: BUDGET BRINGS A BIG INCREASE IN TAXES AND INVESTMENT

UK chancellor Rachel Reeves has announced £40bn of tax rises and pledged to improve public services in Labour’s first budget in 14 years. Employer national insurance will rise by 1.2p to 15p from April, along with a reduction in the earnings threshold for this tax. The government expects this to raise £25bn annually by 2030. Corporation tax remains capped at 25p during this parliament. Capital gains tax will increase, with the lower rate rising from 10p to 18p and the higher rate from 20p to 24p, raising £1.7bn annually. Inheritance tax changes include a new 20p rate for shares in Aim-listed companies and reduced relief for business owners, expected to raise £2bn a year.

Investment in health and education will increase. Overall, the budget projects a rise in the tax burden to 38.3% of GDP by 2027-28. The financial markets had a mixed response to these announcements. The UK-focused FTSE 250 index rose initially, while gilt yields climbed to a one year high and the pound fell against the dollar.

AUTOS: OUT WITH THE OLD AND IN WITH THE NEW

Legacy car makers continue to struggle with falling Chinese demand and the growth of specialist electric automakers. Recent stock market updates highlight the extent of their problems. Volkswagen’s Chinese sales are down 9% this year contributing to a 64% drop in quarterly profits. VW is also factoring in the cost of a major restructure. Mercedes and Porche both announced cost cutting measures following a sharp reduction in sales in China and Europe, and falling profit margins. Foreign automakers have seen their
share of China’s market fall from 64% in 2020 to 37%. Meanwhile, Stellantis, owner of Fiat, Peugeot and Jeep, reported falling sales in the US and Europe led to a 27% drop in revenues.

In contrast, quarterly revenues at Chinese EV maker BYD exceeded Tesla for the first time as sales rose 24%. Its efforts to gain market share have come at the expense of profitability but this is still far better than legacy car companies. Last week Tesla also reported a positive update as it said strong sales helped revenues rise 8% last quarter.

TECH: INTEGRATION OF AI HELPS DRIVE PROFITS

US tech giants reported better profits and growth. Google reported revenues rose 15% in the third quarter compared to last year, as its cloud business expanded by 35% and
said a quarter of its new code is now AI-generated. Microsoft’s revenue rose by 16% in the same period, driven by robust demand for cloud computing. However, it warned of cooling growth and ongoing AI capital expenditures. Meta’s revenues surged 19% for the same period, beating expectations. Daily active users across its suite of apps grew by 5% to 3.3bn people.

Microsoft, Alphabet and Meta will spend 15-25% of their annual revenues from 2024-26 on AI infrastructure, which will support chipmakers like Nvidia. Microsoft is generating recurring revenue from corporate subscriptions, and Google from integrating AI into its products. Facebook, however, is developing untested products like Threads, virtual assistants, and AI video ads, whose value is yet to be determined. The focus on reinvestment over returning capital to shareholders and some weaker forecasts saw tech shares decline.

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