Markets Wrap: Bond Market Turmoil, Inheritance Tax and AI risks

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Welcome to the Merrin Talks Money Market Wrap, where we talk about the biggest moves in markets this week and what's driving them. I'm John Stevick, senior reporter and author of the Money Distilled newsletter. Merrin's out today, but joining me in the studio is Bloomberg's team leader for MarketsLive, David Goodman. David covers UK markets today and squawk in London.

And today's show, we thought we'd probably chat about, well, basically what's been going on in markets this week. We've got the kind of, I hate using the word carnage, so I'll just say sort of like the messiness in the bond markets. We'll have a wee chat about AI as well and maybe a wee chat about what happened at the Tory conference and specifically what they mentioned about inheritance taxes. I think that was probably the most eye-catching thing to come out of that. David, thanks very much for joining us. It's good that you take time out of your a rather hectic markets week to talk to us.

So yeah, what's been the big driver in markets this week?

I think that's a really good question because you said bond markets are messy. That feels like a bit of an understatement. I mean, I was kind of preparing for this, looking at where markets were and then, you know, leave your desk at half now and then there's been a massive bond rally. So trying to get a handle on this is quite tricky. And I think one of the concerning things about this, I think particularly, you know, in Europe is that I haven't really seen a big trigger for anything. I mean, obviously we have concerns about France and French risks, but if you look at France now versus France, say a month ago when the spread was below 100, the French-German spread.

Actually, this is the gap between French government bond yields and German government bond yields.

Yeah, so the kind of bond premium is a kind of measure of how much riskier France is. And France and Germany used to be seen as similarish credit i mean you know germany was always the the kind of benchmark but france was kind of there we call it kind of semi-core and like it wasn't a big risk but it wasn't like the safest credit but so that that spread was below 100 basis points even in mid feb mid-september it's now kind of blown out to 150 no i do i mean take any guess where it is now and you'll be wrong in five minutes time but it's it's been massive but.

And that's something just to be clear we haven't seen since the Eurozone crisis. Cause the thing that struck me was that I remember saying, oh, that's the highest it's been since June, 2012. And then realizing that July, 2012 was when Mario Draghi made his, whatever it takes speech. So you really, you really are talking about this. This was the crisis period here.

Yeah. I mean, interestingly, back then, France wasn't the problem. I think it was Spain and it was Italy. It was obviously Greece. There were all these other countries who are a bigger problem and France looked relatively okay, but. obviously what the ECB did in response to that after that whatever it takes speech closed these spreads down massively and I remember I was getting kind of geekily excited this time last year there's you know the spread between Germany and any of the eurozone bond is I can't remember where it was but it was like there was a 70 basis point spread across the whole market it's like that just is mad when you I mean I started my career in 2011 2012 when we had spreads that completely huge blown out massively and were really causing

causing problems so And obviously, we're seeing some of that come through today at the moment. But I think if you're France, nothing has really changed fundamentally in the last two weeks. There's been some political noise. And obviously, we've kind of got the unrest, which is a big social problem. But I think it's interesting that in the past, we've had these episodes in French debt. It's been a clear kind of political trigger, either the fall of the government and no confidence budgets getting through. We haven't really had this time. It's almost just that there was this big vibes shift where suddenly it was like, oh, France is a problem. And as soon as that thought entered people's minds, selling was the kind of default mode. And then we've

just seen this move, this kind of gathered pace. And the worrying thing about it is that it's spread out into other European countries. I mean, Italy's been moving pretty much bang in line with France, despite, you know, we were talking earlier in this year about Italy being, you know, people are positive in Italy, like they like what's going on there. That hasn't really helped them. I mean, this might mark me as a complete bunkie, but I was looking at the Belgium-Germany spread last week. I don't think anyone's looked at that in the terminal for quite some time.

But the point is it's spreading beyond France. And I think that's when it becomes a real problem that we can deal with idiosyncratic risk. And I mean, the UK has had its fair share of that over the years. But once it kind of becomes... something that spreads beyond one country, then it becomes more of a problem for the ECB and other people.

And how much do you think this is to do with basically the oil price? Because obviously that has been, it feels as if this week we had another, sorry, we've been swinging from, oh, this is nearly over to, oh no, it's getting worse. And this week it's felt like, oh no, it's getting worse weeks. And obviously oil went back above $ 100 a barrel. And today, again, it kind of spiked to about $ 105 for a bit. And I'm just wondering if we're slightly, because obviously France is blown out and obviously France does have its problems. And, you know, I guess the fact that we're trying to get another budget through perhaps started to make people think about it.

But at the same time, we do also have this kind of oil prices just automatically push up inflation rate. push up interest rate expectations and maybe it's just it's a kind of global move but france is just the very obvious tip of the spear.

Yeah i think so because i mean the oil price is an interesting one because it has kind of just been around a hundred dollars a barrel in either direction for quite a while and you know we've got three percent we had about three five percent move today That would have been huge a few years ago. And now it's just kind of par for the course. We haven't seen that kind of step change from, say, like 80 to 100, which I think is what sparked another leg of bond selling later in the summer. But also it hasn't gone up again and it ratcheted higher. But I think if you're thinking about how central banks respond to this, we have entrenched high energy prices now. And I think there was still some hopes that there was going to

be an off ramp in, in, in the conflict in Iran. And that was no allow inflation to kind of mechanically come down. And it is that threat of those second round effects now that I think perhaps people are worried about where, you know, inflation feeds into wages feeds into inflation and that kind of develops that, that cycle. I think that is actually one of the key differences between now and the debt crisis in Europe in 2011, 12, that you mentioned, there's been a lot of kind of talk about that, but I think back then. central banks had room to react and they had the mandate to react because of just the situation. And they had all the tools at their disposal. Now we've come off a decade where central banks have cut rates to zero, done QE,

done so much. And now we're seeing a big inflation spike. And where inflation is now, it's just a lot harder for any bank to come out and say, we're going to cut rates because they just lose their credibility. And then you kind of reinforce this spike in yields because people just think that hundred banks aren't serious about inflation mandates so therefore they they sell bombs so the the kind of tools to solve this crisis perhaps aren't as obvious as they were back then and that's kind of this slightly worrying thing and also when i know we get technical and we talk about spreads but just in terms of absolute yields as well yeah france is whether or not you know the spread over germany is 150

if germany was at zero that would be fine but germany's germany's at three and a half france is nearly at five now so that is a real problem for governments that are having to pay these high interest rates. And I think that's perhaps what makes this worse, particularly for budgetary concerns. And again, coming back to the UK, we see this in the interest bill that the government's facing.

It's just ballooned beyond anything we've seen before. And when interest rates get entrenched like this, it becomes very difficult to get your way out of that.

Yeah, and I suppose the other problem here, and I've kind of mentioned this before, and it sounds... I think, well, obviously, historically, this is a normal interest rate. And the post-2010 rates of kind of near zero were incredibly abnormal. And so on the one hand, this is, in a funny way, it's almost healthy. But the flip side of that is that it's easy saying that, but now you need to adjust to it having been at zero for 10 years and everyone's finances have shifted to accommodate zero. So, you know, that's why people's mortgages are getting more expensive. And it's all very well saying, well, when I took out my first mortgage in 2001, that was like, you know, 7%.

But also, you know, your house price was about like, you know, a third of the cost that it is now. So I think that on the one hand, yes, this is normal. On the other hand, getting from where we were to the new normal, causing an awful lot of pain and it's as you say it's the same thing on the government balance sheets because the last time interest rates were this high debt to GDP wasn't sitting at 100%.

It's quite an obvious point but it's also one I think that needs to be kind of made repeatedly. It's after the period of the pandemic where government spent huge amounts of money and GDP went so much higher and all that was funded at near zero. I mean negative rates used to have in the Eurozone and That was kind of a big thing. But I think just as homeowners need to refinance, government needs to refinance. Government, we're going to switch to shorter-term debt to kind of help ride out this storm, which, again, sounds like a good idea, but then you're just... the rollover risk becomes real and you know who's to say interest rates are going to be any lower in two years time i mean the signs are they may not so it's a kind of

it's a pretty big risk to take and i think you're right that i think we got used to having these rock bottom rates and even talking about normalization of interest rates the amount of time people spent about talking about is the boe going to height rates from 0.5 to 0.75 percent in I mean, I was one of the people writing these things, but the amount of words that we spent on that, and it felt like this really big deal at the time. And also, I think there was this concern that it was going to break the economy if you hike rates by a tiny amount.

And I suppose looking at this in a slightly positive way, we had interest rates go above 5% and the economy didn't break. The housing market didn't break. It slowed and transactions slowed down. Do you remember we were talking, we had this conversation probably four or five years ago about Some of the more lurid house price forecasts, they're going to crash 10%.

Yeah. And obviously there has been a real terms hit. But in terms of absolute levels, I think basically we just saw transactions fall off a cliff. We didn't see prices.

The prices, the only, there's prices have fallen in specific sectors. Like the whole prime central London is quite an eye-catching one. But you're right. I mean, it's the prime central London's down like 27% since 2014.

Yeah.

But you absolutely wouldn't say that for the average UK-wide house. Flats are a bit trickier there.

Well, there's a whole bunch of other things going on there. There's a lot of other reasons for that.

And quite right too, actually. But I mean, that is a really good point, because I suppose one thing that Britain and other countries that really suffered a hit in 2008 have on their side is that consumers did deleverage. So by the time we got to, the big bouncing rates in 2021, 2022, the housing market just wasn't as big.

It wasn't as big in bank balance sheets. It wasn't as big in consumer household balance sheets. And everyone had a fixed rate mortgage as well. Whereas in 2008, everyone was like, you know, there's like two and a half percent equity in an interest only loan. And their payments were just massively overstretched. But I think it's, yeah, so I think that it's important that we don't get, I guess, overly apocalyptic about it. But there's definitely the pain and the kind of public sector balance sheets does not look good.

No, and I think obviously that's, for the UK and the budget that's coming up, there isn't the drama that you've got around France, like, will they get through the House of Commons? Because obviously we've got a different political system, but the trade-offs are super clear and you can see that when you have this interest rate bill hanging over your head and also you're so the bond market is in this mood where it can move very quickly very don't move very fast on not very much i mean that's come back to the front front that's obviously what we've seen there so there's quite a narrow landing zone for yeah for the government to get this right because you know we've we've obviously had some budgets in the

past that have caused massive reactions but then we've had relatively small things over the last two years that have done the same thing yeah and so i think And some of it is just to do with the mood in the markets at the time. And I think if, you know, if Healy comes out and, say, cuts Headroom a lot or doesn't show that he's kind of serious about both sides of the ledger, then that could be a moment that the UK, which is, I think, hasn't been as vulnerable during this latest bond time as it has in the past. Yeah, definitely not. You go back to...

started this year or even last year when when we had these episodes of bond stress the uk we used to have a joke that like the market's basic basic reaction was you know you worry about bonds and then you sell the uk 30 years yeah that was the pain point and for various reasons this time around i think partly that investors are given burnham a bit of a yeah a kind of window of opportunity to to kind of at least the benefit of the doubt and partly some of the stuff the boe have done around um their bond holdings that they've kind of cancelled some of their longer dated sales and the uk is selling less of this stuff anyway so that's kind of helped bring some solidity to the um to the long end but you can see that ending and the uk could

very quickly like become the focus of the bond market again and if you're the focus of the bond market that's very rarely a good thing yeah.

It's no fine i mean that's interesting because one thing i thought um telling the tory party conference was that and their own reporters mentioned this, it's almost like there's now getting a more traditional split again between Labour and Tory in that you have the Tories talking about tax cuts and you've got Labour basically talking about tax rises to pay for extra public sector spending. And that's something that we're kind of used to is what you expect from the left versus right party. But the one thing I kind of always thought, it's probably of interest to our listeners, but this idea that If the Conservatives get in, they're going to raise the inheritance tax threshold to a million pounds for a couple. So 500,000 pounds each from

the current 325,000 pounds. And instead of having this kind of resident, your family home allowance, where you get a certain amount of extra IHT threshold, as long as you pass your home on to your direct descendants, it's going to be basically any value of house. that can be passed on to your direct descendants. And much as I am not a fan of IHT, this strikes me as being rife with potential problems for the housing market. I don't know about you, but the whole, I thought part of the point was we want to hold people in downsize.

This doesn't feel.

Like it encourages that. As opposed to buy the biggest house you can as a kind of tax-efficient vehicle. Do you know that? I mean, I think, from a purely market perspective right now i don't i didn't see any kind of conversation around this come through i think it's you know it's one of those things where people often talk about the leader of the opposition is one of the hardest jobs in politics i think when you're making a speech and spending money that you know you're not in control at that moment it's probably one of the easiest because you can have these kind of eye-catching policies without necessarily having to I know the Tories have laid out a plan of how they're going to play for them,

but it's kind of untested one that they've been, you know, it's, everyone can talk about these cuts if they're not making them and it's making them when you come into office. I think it felt like Inheritance Act was one of those levers that the Tories have pulled in opposition before. I mean, classically, back when Brown was about to call the election in 2008, 2009, it was a lever they went from and that kind of scared Brown off and Yeah, I think, you know, it felt like something from them was coming, but the way that this is, as you say, the way this has worked out does feel like an interesting way of approaching it. It's not necessarily one that is going to like, you know, the kind of tax wonks on Twitter who come out and give you a

kind of rating. It's not really, it's going to appeal to them. Whereas, you know, I think that some of the labour policies you saw from Birmingham around social care and the triple lock were more perhaps designed to appeal to them than this one. This is a very immature kind of, you know, that kind of heart thing, isn't it?

It's a heart rather than head approach.

Yeah, I mean, that's interesting you mentioned the Gordon Brown kind of wobble because obviously one of the things that people think might happen is that Andy Burnham might call a snap election for early next year or possibly even earlier. How much do you think, it's just now that you've raised that, I mean, how much do you think the IHC thing might have been aimed at stopping them from putting them off doing that?

I don't know. I mean, it, yeah, I think, especially coming out to Burnham Street where he's given very long-term views.

Yeah, yeah, yeah.

Obviously there's always been, he's been quite explicit about not having an election and there's various reasons why he may or may not. And I think this to me just felt like more of a, a kind of statement of the offer that the Tories were given to the, obviously they're in the situation now where they've got the left and the right and they need to they're kind of trying to differentiate themselves because there's a risk they do get squeezed on on either side i suppose so yeah i think that's that may maybe more but again i have no idea like.

Oh no it's always interesting to think about these things because that's part of the problem isn't it because i think your point about the head versus the heart thing is a really good one because a lot of if not all of the policies that are aimed at the heart are actually not that great headwise a lot of the time um which is why we're in the situation we're in with the triple lock for example um but yeah i think that's a really good point but anyways getting back to markets um obviously the other big trend that is still ongoing is ai and one thing i kind of noticed this week um was well A there's a fairly well known locally strategist called Joaquin Clement he's over at Panmure Liberum and he reckons the AI bubble

is going to burst in the next two years and he's got a kind of tentative S & P 500 target for the end of next year of 5000 which is a lot, it's a big drop from where we are now. And I also noticed that Ray Dalio and Michael Burry have the big shot fame, and I realise he's kind of a perma-bear, but at the same time still someone interesting to listen to. We're both coming out and talking about how it feels more imminent than it did.

And also this morning we had Samsung reporting record-breaking profits, and actually it still ended the day down 2.4%. I was just wondering, have you got any sense of how AI is rippling through the kind of wider market this week? Because it does feel as if the. I guess maybe it's because the anthropic IPO is coming up.

There's a sort of sense of nerves ahead, but it feels as if we must be getting to some kind of point where all of this stuff comes to a head in some way.

I think the Samsung... earnings are interesting ones to look at because he said they weren't, they weren't bad by any means. And it just shows you how sky high the expectations are in this X. And I have so like the, the bar to, to be in, to keep this going is getting higher all the, all the time. I think one thing is that my colleagues on markets live in the U S have been writing about allies, how concentrated the rally in the S and P has been, and that all this risk is piled into very kind of particular things. And the breadth of breadth of this is, is really quite concerned and they, you know, produce all these charts that show this is looking like the top boom and then burst or all sorts of things but

i think there are you know i think that would be the risk that so much of the rally is kind of predicated on this idea that this can carry on kind of building and building and building both like metaphorically and also literally in terms of data centers and compute and maybe it can but there's also obviously the further down this road you get the more those kind of risks are and we haven't really had the kind of liberation day sell off that.

Yeah.

You look at that now, that was like kind of barely a bump in the road. We took us a while to get back to the highs in the SMP, but we're there again now. Yeah. I think there is, I suppose it's, you know, coming from a kind of journalistic background, there's always a sense of when things are going up, everyone's immediately looking at the reason why it might, why it might come down. And, you know, you've, if you've kind of, believed in this rally from the start and I imagine you've done pretty well for that because people have been, I think similar warnings have been coming for quite a long time in the past as well. Yeah, absolutely.

People have been talking about a bubble for years.

One thing that I thought was quite interesting was that we did see that wobble kind of early September when the kind of AI safety concerns kicked off and we saw more talk from the AI companies themselves about pausing or pacing or however they wanted to cause it. But again, that feels like that's that was a kind of one-off thing that that took place over a weekend and yeah.

We kind of shrugged off well 10 extinction risk i guess we'll just have to put up with.

It and the company said we're going to slow down and now you know we've since then i'm sure we've had new models from both of them that are doing all these kind of yeah talking earlier about the the maths uh the math stump that happened earlier where hundreds and hundreds of puzzles came out and I think puzzles might be understated. Secrets of the universe. Yeah, I think it's probably a better way of putting it. But there is obviously that undeniable progress and that, you know, I suppose when it's due and stuff like that, that kind of explains why people still do believe in it. And, you know, we have got the Anthropic IPO probably coming this year. There's the OpenAI one. I think the last that we heard, that would be, that's kind of pushed

back to next year. But there is, you know, those two feel like very big events that, and also, you know, incredibly clean ai plays yeah yeah after that so yeah i wondered.

Yeah i guess yeah it's the question of whether they suck all the oxygen out of the market or if they just end up being like spacex because obviously spacex was a big deal but it doesn't seem to have had a lasting impact.

On the market back pretty much it's like the price as well everyone was tracking that on the way down and yeah that's kind of back to basically where it was when they got issued.

I suppose this is the problem we don't have a crystal ball so I guess the only thing you can do is stay diversified and just be aware that there is a lot of concentration in the markets and you know your S & P 500 tracker used to be whatever 20% in tech and now it's nearly 50% but beyond that trying to kind of call these things is a bit of a mugs game.

But then it's also linking back to what we were talking about at the start in terms of the bond yields and that like because all these companies are wishing death at a kind of scary rate as well then that is part of the reason i think we're feeding into these high high yields and if you know traditionally bonds are this kind of safe dull investment that you just buy you forget about and they they kind of form part i guess like you know if you're happy to buy us 30 to 6 that isn't that isn't a terrible deal but only if you can.

Hold to maturity exactly that's now you can probably do that i'm pushing it now Well, look, thanks very much for your time, David. I really appreciate you taking the time to come on. Hopefully see you again in the future. Thanks for listening to this week's Merrin Talks Money at Marketswap. If you like our show, rate, review and subscribe wherever you listen to podcasts. And also be sure to follow me on X at John underscore Stepak. This episode was produced by Summer Sadie, Moses Andem and Jennifer Seeley. Questions and comments on this show and all our shows are always welcome. Our show email is medinmoney at bloomberg.net. Special thanks to David Goodman.

Markets Wrap: Bond Market Turmoil, Inheritance Tax and AI risks

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