The financial markets are sending a clear signal today: credibility has a price, and the UK is buying it cheap. While the US economy continues to defy gravity with a GDP print that would make a Silicon Valley unicorn blush, British gilt yields are falling as investors reward the Treasury’s newfound fiscal discipline. It is a tale of two bond markets, and the message is unmistakable.
Let us start across the pond. The American consumer is still spending as if there is no tomorrow, and the labour market remains stubbornly tight. November’s non-farm payrolls exceeded expectations by a healthy margin, and core inflation is proving stickier than a toffee pudding. The Federal Reserve, despite its recent dovish pivot, now faces the uncomfortable prospect of reversing course. Wall Street is pricing in a 40% chance of a rate hike by July. That is not a bet on strength; it is a bet on policymakers losing control.
Yet the dollar is not rallying. It is drifting lower against a basket of currencies, and capital is starting to look elsewhere. Why? Because investors are beginning to question whether the US can maintain its fiscal trajectory. The national debt is now $34 trillion and climbing. The Congressional Budget Office projects a deficit of $2 trillion for the current fiscal year. That is 7% of GDP. In peacetime. With unemployment at historic lows. The maths simply does not add up.
Now turn to the UK. The mood in the Square Mile is cautiously optimistic. The Chancellor’s Autumn Statement, delivered with the solemnity of a man who knows he cannot afford to spook the markets, has been received well. The Office for Budget Responsibility forecasts that the government will meet its fiscal rule of debt falling as a share of GDP by the end of the forecast period. That is a low bar, but it is a start. The Office for Budget Responsibility also notes that the fiscal headroom has increased from £6.5 billion to £13 billion. Not exactly a war chest, but enough to make traders feel the government has a plan.
What does this mean for the average investor? For the domestic saver, lower gilt yields translate into better terms for mortgage rates, though the transmission mechanism is glacially slow. For the international capital allocator, it means the UK is no longer the pariah of the developed world. The risk premium on gilts has shrunk. The spread over German bunds is now 180 basis points, down from 220 at the peak of the Truss-era panic. That is real money.
There is a lesson here about the psychology of markets. They do not reward recklessness. They do not reward wishful thinking. They reward the steady, boring grind of fiscal consolidation. The US may be growing faster today, but the UK is building a more sustainable foundation for tomorrow. The bond market is voting with its yield curve: lower here, higher there. It is the ultimate referendum on policy credibility.
Of course, there are risks. Global growth could falter, dragging the UK down with it. The war in Ukraine continues to cast a shadow over energy prices. And the domestic labour market shows signs of cooling. But for now, the market is saying that Labour’s fiscal rules, however modest, are a step in the right direction.
In the end, the bottom line is simple. The US economy is running on adrenaline and debt. The UK economy is running on austerity and hope. For the first time in a long while, hope is winning. The question is whether it can last.
