Happy New Year to you. Having had a little break, returning to work seems like not a lot has changed. UK politics remains in a frightful mess, the Chancellor has run off to China with the Governor of the Bank of England, whilst the pound falls in value and UK Debt yields rise back to 2008 levels leading markets to question whether Rachel Reeves can indeed meet her own fiscal rules. Elon Musk is no longer just happy with being Donald Trump’s best friend, he now has developed an unhealthy interest in Uk politics. Amongst all this, we are only 10 days away from the return of Trump to the US Presidency. Phew.
I will start this week away from markets and politics for a brief comment on the terrible events unfolding in southern California, with more than 30,000 acres destroyed since huge fires broke out on Tuesday. The largest of the fires, the Palisades fire, is only six per cent contained and currently spans 19,978 acres. The second-largest, the Eaton fire, is still zero per cent contained and continuing to grow. As I write, more than 10,000 structures have been destroyed, 180,000 people are under evacuation orders and ten people are confirmed to have died, though that number is expected to increase. Additionally, 20 people have been arrested for alleged looting and police have taken a man into custody on suspicion of arson after he was found “attempting to light a fire” in the Woodlands Hills neighbourhood of Los Angeles.
Why has tackling the fires been so hard? Firefighters have been hit by a series of unprecedented conditions which have compounded to make their jobs even more challenging. Ferocious winds of up to 100mph not only helped the fires to spread faster than normal across the drought-stricken Californian landscape, but also prevented aerial units from dropping water as the fires began to spread. Although the winds calmed slightly on Thursday, they are forecast to pick up again over the weekend. The sheer scale of the fires has also pushed crews to their limit at a time of year when such disasters are not expected, and put immense pressure on fire hydrant supplies which are not designed to cope with multiple thousand-acre fires at once.
There are also political rows brewing over budget cuts to the Los Angeles fire department and a lack of adequate warning from the mayor’s office before the fires broke out. Global climate issues cannot be overlooked as the EU’s Copernicus Climate Change Service reported that 2024 was the first year where the annual global temperature breached the 1.5C threshold set out by the Paris Agreement. “Multiple global records were broken, for greenhouse gas levels, and for both air temperature and sea surface temperature,” the report said, “contributing to extreme events, including floods, heatwaves and wildfires.”
While it is still too soon for a detailed attribution analysis to be conducted into the California wildfires, scientists are clear that rising temperatures driven by the burning of fossil fuels have increased the speed, intensity and frequency of such fires. Researchers from the National Oceanic and Atmospheric Administration also found that the climate crisis has caused a 172 per cent increase in burned areas of California since the 1970s, with a further increase predicted in the years to come.
Speaking at a news briefing with President Biden yesterday, vice-president Kamala Harris said: “Whereas years before we would talk about a particular season of extreme weather, we are seeing that it doesn’t matter what month of the year [it is],” she said. “We are beyond the point of calling it fire season.”
The return of President Trump has worried many with regards to global climate change and it was sad to hear that BlackRock has become the latest financial company to bail out of a big climate change industry group ahead of Donald Trump’s return. Membership in Net Zero Asset Managers had “caused confusion regarding BlackRock’s practices and subjected us to legal inquiries from various public officials”, the money manager told clients this week. Something has to change, but without strong global leadership it is hard to see how and when this change will come about.
Back to markets and I am sure you will not have failed to notice that the pound sterling fell to the lowest level in over a year on concern the government will struggle to keep the deficit in check as borrowing costs surge. Investors have been irked by the UK’s escalating debt burden and persistently high inflation. The sell-off in UK government debt markets could push up mortgage costs for some 700,000 British households when their fixed-rate deals end in 2025. The recent upheaval, driven by worries over persistent inflation and heavy public borrowing, could keep borrowing costs higher for longer.
The government has tried to calm markets by vowing to stick to its fiscal rules, as Darren Jones, number two at the UK Treasury, told MPs that “UK gilt markets continue to function in an orderly way”, this after the 10-year gilt yield rose to 4.93 per cent, its highest since 2008. “There should be no doubt of the government’s commitment to economic stability and sound public finances,” Jones said. “This is why meeting the fiscal rules is non-negotiable.” Jones’ appearance came after Sir Lindsay Hoyle, Speaker of the House of Commons, accepted an urgent question from the Conservative opposition about the “growing pressure of borrowing costs on the public finances”.
UK borrowing costs have indeed risen sharply as investors worry about the government’s heavy borrowing needs combined with lacklustre growth and persistent price pressures. Jones argued it was normal for gilt prices to vary and that there was still strong underlying demand for UK government bonds. “The latest auction held yesterday received three times as many bids as the amount on offer,” he said. The minister said the Treasury was still working on a multiyear spending review due this summer on the basis of assumptions set out in the October Budget. However, he acknowledged that the Office for Budget Responsibility, the independent Budget watchdog, would come up with fresh forecasts on March 26, which could then have an impact on discussions with ministers.
The recent bond market strains also raise the spectre of further tax rises or spending cuts. The Treasury has signalled that, if necessary, it would reduce expenditure rather than increase taxes. Shadow chancellor Mel Stride, who had posed the urgent question, said Reeves should have attended parliament herself. “Where is the chancellor?” he asked. “It is a bitter regret that at this difficult time, with these serious issues, she herself is nowhere to be seen.”
Reeves left herself a slender £9.9bn of headroom against her revised fiscal rules in last year’s autumn Budget even after announcing a £40bn tax-raising package that aimed to “wipe the slate clean” on public finances. The chancellor’s key fiscal rule is a promise to fund all day-to-day public spending with tax receipts by 2029-30. Increases in government debt yields have since put that budgetary wiggle room under threat. The level of bond yields is an important determinant of the budget headroom, given its implications for the government’s interest bill, which exceeds £100bn a year. Volatility in the Gilt market has become something of a common occurrence in recent years and I can’t help but feel that this offers a very interesting investment opportunity that we will be looking back at in six months’ time. This is certainly the view of the investment team.
Here we are then, another year filled with opportunities and concerns in equal measure which seems to be the modern way. Markets have started to slowly move back up after a little year end wobble and the outlook is good for proactive investment managers to add value to our clients’ portfolios. The UK market has been under the cosh a bit, however a weaker pound added to one of the most fairly valued markets, could bring a surge in M&A back to the UK and who knows, the UK stock market could end up being the star of 2025. As always, if you should have any questions, please do get in touch, until then, have a lovely weekend.
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