UK Gilts brush off rising energy price cap, as Tony Blair comes to the rescue

The tech boom is back. A roaring Tuesday session for US stocks that saw the S&P 500 reach another record highs, and Micron reach a $1 trillion valuation, spread to Asia where South Korean chip maker SK Hynix followed suit and crossed the $1 trillion barrier. Investors continue to pile into AI linked stocks, as hopes rise for a swift resolution to the US/ Iran conflict. Along with Samsung, SK Hynix, which is a key supplier to Nvidia, makes up 40% of the South Korean Kospi index. This is why, even though Asia is reeling economically from the energy price spike, the stock market continues to boom.

The surge higher in US stocks is boosting Europe, where sentiment remains high. The oil price is down 2% today, even though no deal has been formally announced between the US and Iran to end the conflict in the Middle East. Brent crude oil is back below $94 per barrel, and the oil price is lower by 10% in the past week. This is boosting overall market sentiment; bonds are also higher and 10-year yields are falling across the major economies.

The UK 10-year yield is lower by 4bps today and is down by a whopping 34bps since the 10-year yield peaked on 18^th May at 5.17%. There is a clear link between the oil price and UK yields, so when the price of oil dips it drags the yield lower with it. It may be ironic that UK yields are falling today even though the price cap on household energy bills is set to rise by 13% in July, the highest level in more than 2 years. This is an increase of £221 per year per household, and Ofgem also said that it is likely that we will see elevated energy prices throughout the winter.

So, why are bond yields not responding to this news? There are a few reasons. Firstly, the price cap is not rising as fast as it was in 2022 due to the increased use of renewable energy in the UK. Secondly, if there is a peace deal in the coming days, that includes reopening the Strait of Hormuz, then energy prices could fall further, which could limit further upside on energy bills in future. Added to this, although the rising price cap will put upward pressure on inflation, the second-round effects are likely to be minimal, since the UK economy is showing signs of weakness and the unemployment rate is rising.

After selling off earlier this month, UK Gilts are attracting interest. This is being helped by a softer tone on fiscal rules and tax rises from Labour leadership hopeful, Andy Burnham, which has slightly reduced the political risk premium added to UK debt. On top of this, former PM Tony Blair warned the Labour party to avoid a lurch to the left, stating what to  many seems obvious, that a move to the left will not boost the party’s  chances at the next general election. Hard left Labour policies are seen as economically and fiscally destructive. Blair warned against tax rises and supported cutting the benefits bill. If Blair’s suggestions can be translated into policy, this could add to Gilts’ attractiveness, but this is a big if.

European stocks are higher today, but the UK’s FTSE 100 is struggling, as it suffers from a lack of tech and continues to get weighed down by Shell and BP, which are lower on the back of a falling oil price and continued executive issues at BP. A good spate of earnings news for UK retailers has seen M&S and JD Sports rise to the top of the FTSE 100. If you are worried about a tech bubble, the FTSE 100 is a good hedge in the current environment.

Ahead today, the market will be looking for more news from the Middle East to sustain the positive risk sentiment. US index futures are pointing to a higher open later today, and Goldman Sachs raised its forecast for the S&P 500 this year to 8,000.