Yields On Bonds Are Rising Steadily

Despite the fact that the markets are calmer than they were six months ago, interest rates are still climbing higher.

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Markets have settled but at higher interest rates 

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There were a few things that caught my attention this morning. Let's take a quick look at them.

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Abhinav Ramnarayan, one of my colleagues, points out that the UK credit markets (i.e. bonds) have now fully recovered from the panic of Liz Truss's era.

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Abhinav points out that the "spread" between the high-yield (junk) debt of UK companies and the debt of euro-zone companies has now returned to levels last seen during the summer, which is much closer to the levels seen in July. Therefore, it can be stated that there is no longer a panic premium on UK corporate debt compared to euro-zone equivalents.  

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It is, of course, good news to hear this. Personally, I think that Truss, the former UK prime minister, has taken a great deal of flak for this issue and I think he has taken way too much heat for it. As a result, the focus on politics has been unhelpfully distracted from the fact that our pension funds should never have been able to get into a position where they would have been able to derail the UK government bond market by implementing some ill-considered hedging strategies.

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It is, however, nice to see some calm in the markets after the original blow-up, no matter what the reason for it was.

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In spite of this, spreads are one thing, and rates are another. It is quite another thing to have interest rates at an absolute level and borrowing costs at an absolute level. We all have to get used to the fact that the overall rates will be higher than before, even though UK borrowers will no longer be required to pay an additional LDI/Truss-driven premium.   

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During the first few minutes following Kwasi Kwarteng's budget speech, gilt yields went down to where they had been before he stood up to give his speech. However, they have now returned to where they were the day after he had decided to "go for growth.". In the meantime, the bund yields are at their highest level since 2011 - they were still in negative territory at the beginning of last year. 

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There has been a calm in the markets, but they are likely to revert to a "new normal" with interest rates likely to remain high for an extended period of time, reflecting stubborn inflationary pressures. It is a topic that Pippa and Merryn discuss in more detail on their podcast, so make sure you listen to their episode if you haven't already.  

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Health Not Wealth

Throughout the last few months, we have been discussing the drop-out rate from the UK labor force on and off on a regular basis. Another study has been released by the Office for National Statistics, which confirms previous studies which have suggested that most of the post-pandemic inactivity problem can be attributed to an increase in long-term illness rates, as opposed to an increase in early retirement. 

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Obviously, I would like to hear from you if you have any thoughts or observations on this front, so please email me at the usual address if you have any comments or observations and I'll print the best ones.

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Merryn Talks Tax

It was Merryn who dropped me a note this morning about tax policy and the clever mind games played by the government. Considering that the pre-budget kite-flying is about to come thick and fast, I thought I would share it with you verbatim as I am sure you will enjoy it. 

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If you change the tax regime, you will change your behavior as well. The Scottish government, for example, is making income tax policies based on the pretense that this is not the case, and making decisions based on this pretense on the spot (see their income tax policy, for instance). Most governments - even those that could be described as vaguely competent - are aware of this fact - and make policies accordingly.

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The UK has recently provided a nice example of this. In the 20/21 tax year, there were a lot of discussions regarding the possibility of changing the capital gains tax (CGT) regime - rates were predicted to rise, as well as the allowances for business owners selling their businesses were expected to be reduced. How did it turn out? It has been discovered that there was an impressive spike in the sale of unlisted shares in 2019/20 and 20/21, according to a Freedom of Information request filed by accountancy firm RSM UK. There were 42,400 individual sales in 2019/20 and 55,250 in 20/21. Over the past year, the number of transactions worth over £20 million has increased from 50 to 150.

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In terms of revenue, how much did that bring in? Based on the assumptions that the gains were fully taxable at 20%, according to RSM, the amount of tax that HMRC would have had to pay on the full 150 would have been around £600 million - so the extra compared to 19/20 is roughly £400 million. While the rate did not actually change - allowing speculation that they might run riot in the short term proved to be a rather effective way of boosting short-term tax receipts even though the rates did not actually change.

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“It is unlikely that government officials will wish to cry wolf too many times, but this incident should serve as a reminder that raising taxes is not always the best way to raise money for the government.”