Good news is bad news for US markets, as the bond market could save Kier Starmer’s job

The bond market is in focus once again on Thursday. Yields are rising around the world, but particularly in the UK, as political risks rise once more. US yields are also broadly higher after an upgrade for Q2 growth. The US economy grew at a 3.8% annualized rate last quarter, and this was driven by consumption, the personal consumption index rose by 2.5%, beating estimates of a 1.7% reading. There was also good news around inflation, the GDP price index was 2.1%, and the core PCE index was 2.6%, up a notch from the previous reading of 2.5%.

Fed rate cuts called into question

The bond market is reacting to the better-than-expected US GDP data, as it leads to questions about whether the Fed needs to cut rates further, especially since inflation has picked up in Q3. Added to this, more current economic data was also positive for the US economy. There were signs that the labour market is picking up. Initial jobless claims fell to their lowest level since mid-July, and durable goods orders were also stronger than expected.

The strength of the US economic data has led to a mini recalibration of US interest rate expectations. On Wednesday, the market was pricing in a 90%+ chance of a rate cut in October, that is now 83%. Likewise, expectations for a December cut have also been scaled back.

October looks like a challenging month for stocks

US stocks have opened lower for the third straight day, as good economic news is bad for risk sentiment, and we could see stocks struggle into the end of this month. After defying seasonal weakness in September, October could prove to be a tougher month for stocks, especially if cracks start to appear in the narrative around Federal Reserve rate cuts. Ultimately, the market is likely to focus on Trump’s expected dovish pick for the next chair to replace Jerome Powell, but today’s data suggests that whoever is at the Fed next year needs to be mindful of an overheating economy. There is one question that could limit enthusiasm for stocks in the coming days: Does an economy that is growing at a 3.8% annualized rate really need 4 further rate cuts in the next year?

Is Andy Burnham, Labour’s Liz Truss?

Political risks in the UK is once again spooking the UK’s bond market. Andy Burnham, the mayor of Manchester, seems keen to replace Kier Starmer as Prime Minister. Although Starmer is unpopular and the government’s approval ratings are through the floor, a change of leadership could exacerbate the UK’s fiscal problems even more. 10-year bond yields are higher by more than 5 bps today, 30-year yields are also rising. Although global bond yields are rising, the UK is the outlier, and is a major underperformer compared to our peers.

Andy Burnham’s rhetoric of nationalizing utilities and questioning why the government needs to be in ‘hock’ to the bond market, has awoken the bond market vigilantes. After protecting Rachel Reeves’ job earlier in the summer, the bond market could save the day for Kier Starmer.  The problem with Burnham’s rhetoric is that the UK government needs to be very aware of the bond market, because we have a budget deficit, which has been exacerbated by Labour’s current spending plans. His agenda could widen the deficit and push up borrowing costs even more, which is why bond yields are rising on Thursday.

Weak demand for UK debt another reason Labour should swerve Andy Burnham

Burnham and his leadership bid comes at a bad time for the UK’s bond market. This week has seen weak demand across debt auctions. For example, today’s 9-year debt auction saw demand fall to 2.9 times the amount on offer, down from 3.22 in July. This is not disastrous, but it suggests that sentiment towards UK debt remains fragile.

Stronger yields and better than expected economic data has boosted the dollar on Thursday, which is now the top performer in the G10 FX space, reversing earlier losses. The pound is the second weakest performer, as it struggles once more under the weight of political concerns.

The new normal for stock markets

Overall, global stocks may need to readjust to a new normal, where strong growth reduces the need for lower US interest rates. For now, the data is doing the talking for the Fed, and we could see stocks and Treasuries struggle in the coming days, as the dollar stages a comeback. The Dollar Index broke above the 50-day sma on Thursday, and is trading above 98.00, which suggests there could be further upside to come in the short term.