Tax, spend, explain

• Japanese equities, up +0.6% and the only major equity market in positive territory in sterling terms

• All other equity markets shed c.1% in sterling terms
• Brent crude oil slid c.4% in dollar terms

Last week Chancellor Rachel Reeves delivered Labour’s first Budget in 14 years, announcing some £40bn worth of tax rises by 2029/30, as well as notable additional borrowing, to plug a c.£22bn fiscal hole Labour claim to have inherited from the previous administration and further boost public spending. Taxes are forecast to rise to their highest share of Gross Domestic Product (GDP) on record by 2026.

The government’s headline tax raising measures were increases to employers’ National Insurance (NI) Contributions and to the rates of Capital Gains Tax. Labour’s pre-election manifesto pledge to protect ‘working people’ from tax increases (by promising not to raise income tax, employee’s NI and VAT) will ensure the Budget has a fairly limited direct impact on households initially. However, the Office for Budget Responsibility (OBR) estimate that three quarters of the impact of higher employer’s NI contributions will ultimately hit employees through lower wage growth than would otherwise have been the case, with the remaining quarter being reflected in lower company profits.

The OBR also estimate that the Budget will increase inflation (as measured by the Consumer Prices Index) by 0.4% when measures peak in 2026. It forecasts average inflation of 2.5% in 2024, rising to 2.6% in 2025.

In the days following the Budget, the yield on the benchmark 10-year UK government gilt rose sharply to a fresh one-year high, settling c.21bps higher at 4.526% - the biggest weekly move this year. Sterling modestly weakened by about 0.5% against the US dollar. A combination of rising gilt yields and weaker sterling suggests that markets are somewhat surprised by the scale of increased public borrowing and concerned about the fiscal outlook. Although a long way from the market turmoil following the 2022 ‘mini-Budget’ under former Prime Minister Liz Truss and her Chancellor Kwasi Kwarteng, some investors are now questioning whether financial markets may force the Bank of England’s rate setting Monetary Policy Committee (MPC) to hold interest rates steady this week, rather than cutting by 0.25% as previously expected.

Overall, this Budget is already guaranteed to go down as one of the biggest tax-raising Budgets on record. The Chancellor will be hoping that the increases to public spending will justify her financial plan by kick-starting a period of faster economic growth.

Last Thursday, the technology heavy Nasdaq Composite index sank by -2.7%, while the broad S&P 500 index fell nearly -2%. Mega-cap tech companies Meta and Microsoft announced their latest earnings reports, beating expectations. However, both firms flagged that Artificial Intelligence (AI) infrastructure costs would significantly increase, causing Meta’s share price to retreat -4.1% and Microsoft’s to fall -6.1%, as the market digested the increased pressure on profitability in the coming quarters.

To the contrary, Amazon saw its share price rise after reporting a double-digit increase in quarterly revenues last week. As companies develop and implement AI tools, they demand ever more cloud data storage capacity, and this is expected to present a significant opportunity for Amazon’s cloud business (Amazon Web Services) which seems to have first-mover advantage in this space. The AI rush has also meant significant capital spending on the requisite infrastructure for Amazon, with the firm outlaying billions of dollars on property and equipment in the last quarter of 2024 - nearly double the previous quarter’s spend - with a further $75bn earmarked this year and even more next. Amazon shares were up +7.3% on Friday, pushing the company’s market valuation past $2tn.

Despite it being pre-election week, US economic data remained at the forefront of investors’ minds. The JOLTs (Job Openings and Labour Turnover Survey) report revealed job openings had fallen by c.418,000 to 7.44 million, from a downwardly revised 7.86 million in August, and significantly below expectations of 7.99 million. US Non-Farm Payrolls showed some signs of weakness too, with only 12,000 jobs added in October - well below a downwardly revised 223,000 in September and forecasts of 113,000. The US unemployment rate was steady at 4.1%, albeit flattered by a drop in the labour market participation rate. A strike by workers at Boeing and storms Helene and Milton likely impacted data, however.

Elsewhere, the US core Personal Consumption Expenditures (PCE) Price Index, the US Federal Reserve’s (Fed) preferred measure for inflation, rose by 0.3% in September - the highest level in five months and above an upwardly revised 0.2% increase in August - and the US Q3 GDP print came in at an annualised rate of +2.8%, below the 3.1% estimate.

These mixed data releases are perhaps unlikely to provide the clarity the Fed’s data-dependent policymaking demands when setting interest rates.

 

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