“It is no secret: the bond market, international investors, myself and other fund managers are all saying ‘this government has completely lost all credibility, fiscally’.”
This was the warning from David Coombs, multi-asset fund manager at Rathbones, after gilt yields spiked last week. Last Tuesday, the yield on a 30-year gilt rose by 9 basis points to 5.73%, the highest level in almost three decades.
It has been a difficult period for the government, with deputy prime minister Angela Rayner resigning after she was found to have underpaid stamp duty on a second home – a breach of the ministerial code.
Meanwhile, concerns have been raised about how much faith prime minister Keir Starmer has in chancellor Rachel Reeves, after he hired new economics experts to aid her.
“The government has got itself in a real mess,” the manager of the £3.4bn Rathbone Strategic Growth Portfolio said.
The crux of the matter for Coombs is that ministers “haven’t done what they said they were going to do”, which was to ramp up economic growth.
“They might have focused on it, but they certainly haven’t achieved it. And they haven’t come up with any coherent strategy to produce it. In fact, they’ve done the opposite – they’ve reduced growth, or increased contraction, whichever way you want to look at it,” he said.
One example of this was the National Insurance changes made in last year’s Budget, which raised the rate from 13.8% to 15% and lowered the earnings threshold at which employers pay the charge.
Fears at the time were that this would hamper the economy, with companies finding it more expensive to employ staff.
“The NI tax, which everyone said was ridiculous, has had exactly the outcome everybody predicted. You would hope that they’ve learned from their mistakes, which is a big hope,” he said.
Underpinning these problems is a ‘black hole’ in the government’s finances, which the Labour Party has said was left for them by the previous Conservative administration.
Addressing this will require one of two solutions, according to Coombs. “They’re in a hole and everyone knows about it. So how do you get out of it? There are two things they can do. They can cut spending or they can increase revenue or borrowing,” he said.
With gilt yields rising (and therefore the price falling), he wished the government “good luck” in trying to sell more gilts, as the market is “telling them they can’t do that”.
So the only option available seems to be to “renege on the manifesto” and raise taxes. If the government were to add 1p on the income tax basic rate or 1% to VAT, for example, government bond yields would fall and the market would rally.
However, the manager noted this is unlikely as the government is “beholden to a very large backbench fraternity” who do not want this to happen. This faction have also made it clear that they are unwilling for the government to contemplate welfare spending cuts, he said, as evidenced by the dissent over axing the winter fuel allowance and changes to disability benefits.
One option available that Coombs thinks is more credible is ending the triple-lock on pensions. At present, the government is legally required to increase the state pension by the highest of either average earnings growth, consumer prices index (CPI) inflation or 2.5%.
“I think they will probably end the triple lock. I think it will get announced at the Labour Party conference by Reeves or Starmer that they are reviewing it, and they will stand back and see what the political fallout from that is,” he said.
“The bond market will like it, which might give them a bit of breathing space.”
By pushing back the Budget to the end of November (it is usually held in October), the government may be hoping that it can get the right policy mix to deal with the problems faced – a view Coombs is “not overly sympathetic with”.
“They’ve pushed the Budget right back, which I think is a mistake. My faith in them getting it right is pretty low,” he said.
However, the fund manager noted there is no specific issue with the under-fire chancellor. Although Reeves “has little credibility”, the problems the government faces are “not personal” and replacing her would not fix anything, he argued.
“You need some political bravery, which is in short supply on either side of the house right now. The previous administration was equally as incoherent – let’s be clear about that.”
So what should investors do?
With so much uncertainty, Coombs said there is a “super high” risk that the UK will fall into recession. As such, he is not in favour of owning smaller companies, as these tend to be more domestically aligned.
“The cost of borrowing is rising and the economy is not growing, so do you want to be in a UK small-cap with the UK consumer as your customer? No,” he said.
Similarly, he would be wary of large-cap companies that are tied to the UK consumer. While he owns retailer Next in his highest-risk Rathbone Enhanced Growth Portfolio, he has sold out in the medium and lower-risk portfolios, such as Rathbone
Defensive Growth Portfolio and Rathbone Total Return Portfolio.
“Next is the best retailer in the country by a country mile so it will probably grow through a shrinking market. But looking globally, would you rush into Next right now? Probably not,” he said.
However, he is overweight the UK market, with large holdings in the likes of oil giant Shell, which he is using as an “oil hedge”, as well as stocks that derive most of the revenues in the US, such as food services firm Compass and equipment producer Ashtead.
On gilts, the manager noted that if the 10-year bond hits a 5% yield he would add to his position.
“I am a buyer of gilts at these levels. Not with massive enthusiasm it has to be said but as long as inflation hovers around 3% you are getting a reasonable real return from those gilts,” he said.
“On weakness we would be adding tentatively to gilts.”