In my first (and for some reason clearly not my last) article last month, I attempted (perhaps foolishly) to discuss where rates might go over the course of 2025. I say foolishly as since that time, several elements underpinning my thought process have started to unravel, not least of which is the extent of how much I (and no doubt others) underestimated how much of a complete wrecking ball the Trump administration would actually become in just about all aspects of internal and external affairs.
Whilst the aim of this article isn’t to get overtly political, it is unfortunately increasingly difficult to divorce government policy decisions from the implications for government debt/bond yields and ultimately mortgage rates.
If we start in the US, the Department of Government Efficiency (DOGE), led by Mr Musk, is proving extremely controversial.
At the time of writing it has alleged to have managed to have saved so far around $105bn in costs from government departments (visit doge-tracker.com for a real time feed!). That’s not as much as the $800bn as that’s been wiped from the value of Tesla stock since Mid-December, but it’s a start.
This, $100bn+ of savings has fed through in part to lower US treasury yields, in that
(the logic thus far goes) rather than borrowing potentially having to go up to fund tax cuts, ‘maybe’ internal savings – through lower government spending – can prevent the deficit from rising.
GOVERNMENT-INDUCED RECESSION
The market in late 2024 was anticipating US 10-year treasury yields to rise towards 5% in the early part of 2025. Instead they are now hovering around 4.20% on the back of the above logic and increasing fears of a government-induced recession.
Trump’s seeming love of tariffs and his apparent conviction that tariffs can in a large or even wholly replace taxation as a source of revenue are causing consternation in the markets.
Politics aside, the consensus view is that tariffs are both inflationary (you clearly pay significantly more for goods and raw materials) and potentially recessionary (people have less money to spend on goods and services). A US recession, complete with rising inflation, would clearly not be good news and the effects would be felt over here.
ISOLATIONIST WORLD VIEW
The other impact is foreign policy. Without going into the Ukraine war, from Obama onwards the US has clearly been strategically adopting a more isolationist world view.
Trump is (arguably) just turbo-charging it – on steroids! This increasingly means that
the UK and Europe needs to become self-reliant for defence.
Increasing UK defence spending to 2.5% of GDP was, in the scheme of things, relatively easy to do. However, the reality is that the £16nn increase is likely to get swallowed in short time by existing projects, especially the next generation of submarines.
WINDOW DRESSING
Some 2.5% was, in reality, window dressing – we will probably need to go 3% or higher and how we pay for it will be the challenge: either through taxation, savings in other government departments (as I write the government is looking at the benefits system) or increased government borrowing.
Whilst it is perhaps convenient to blame Trump for all our woes, the increase in swaps over recent weeks is largely down to factors closer to home, namely the CPI numbers out on 19 February.
Inflation came in higher than expected and with more inflationary pressure set to push through the system in the coming weeks including the wine tax increase (clearly you are not supposed to write about what personally affects you but…). We also have the employers’ National insurance increase and the rise in the minimum wage from the start of April.
As its stands it feels as though the UK is walking a tightrope when it comes to a possible recession. How it plays out over the next three months will be a big factor in where rates end up.
