It may have escaped your notice, but Tracey and I were sad to hear of the passing of Radio 2 DJ Johnnie Walker over the new year break. He presented the BBC’s Rock Show and Sounds of the Seventies. Tracey and I often listened to the latter on Sunday afternoons during the winter, warmed by a blanket of nostalgia – well for me anyway as she would point out she wasn’t born until 1970.
Most of the music he played was amazing: Led Zeppelin, Elton John, David Bowie, Pink Floyd, the list goes on. And yet, the dirty secret of it all is that I actually remember none of it from the time! Instead, the 70s was filled with loads of awful pop: Bay City Rollers, Osmonds, Gilbert O’ Sullivan, Clive Dunn’s Grandad and many, many more...
The 70s I remember were brown and beige and awful. Not exactly a time I think about much, outside of Walker’s fantastic shows. But thanks to this government I find myself finding more and more similarities between then and now.
The government spending more without insisting on productivity payoffs, taxing more, inflation rising and possibly falling employment due to planned increases to Employer National Insurance Contributions. This coupled with geopolitical risks keeping energy prices relatively elevated and Ed Miliband’s green energy strategy make me feel very anxious that we could return to stagflation.
To be clear stagflation doesn’t mean runaway, double-digit inflation, which is what we also experienced in the 70s along with the first bout of stagflation. Stagflation can also occur with inflation stubbornly above target, a recession and rising unemployment. We don’t have the latter two at the moment, but I do feel the risk of them arriving is much elevated now.
And this is a problem for our multi-asset funds’ UK government bond positions. Yields rose significantly during 2024 and that trajectory continued into 2025, before easing slightly only recently. I’ve already outlined my concerns regarding the impact of the UK Budget; unfortunately they are playing out. It’s noticeable how many CEOs have come out highlighting how the NICs increase will hurt staffing levels and increase price pressures – and not the usual suspects, either.
What is frustrating is that we held onto our gilts despite our negative views on government fiscal policy. We really didn’t see the scale of the sell-off coming so soon. We still believe the Budget will tip the UK into recession, which is normally positive for gilts as the Bank of England (BoE) would typically accelerate rate cuts into a recession.
A bum note
So why have yields risen? Firstly, I think bond investors are frankly stating that the Chancellor’s strategy lacks credibility and that they expect a fiscal shortfall. Secondly, the inflation outlook looks less promising, driven by the NIC rises and higher minimum wages, which seem likely to be passed onto households, and a government that agrees above-inflation pay rises without demanding accompanying improvements in productivity.
I might add that an energy strategy with strict short-term net zero targets (which were always built on hope rather than a plan) also looks to be inflationary and reliant on subsidies given the timing now looks optimistic!
So I find myself in a bit of a quandary. I want to hold gilts as a recession hedge, but I’m worried that the government’s economic strategy carries significant inflationary threats that could force the BoE to leave rates unchanged despite economic weakness.
The question becomes how deep a recession do we need to offset the inflationary threat? Whichever way you look at it that’s not a question based on enthusiasm for UK plc.
In our multi-asset funds, we’re still just about in the recession camp and are adding to gilts as the yield over inflation is higher, which gives you a bit of a buffer even if inflation proves sticky. Of course, if inflation moves back above 4% and the UK enters recession, we’re looking at stagflation. In that situation we would have to reverse our position quickly.
What’s the trigger to reverse this economic weakness? It’s really difficult to see. The government has backed itself into a corner, and it’s not clear whether they have any levers in terms of raising more revenue, so it must cut spending. Politically, that would be very difficult for them to do, but they would need to find a way without using the ‘austerity’ word.
The take-away from all this is that we could be back looking at a traditional tax-and-spend Labour administration becoming increasingly reliant on debt. I sincerely hope we are not, I lived through that in the 70s and it seriously damaged Brits’ wealth. But at least we had the Stairway to Heaven!
Tune in to The Sharpe End - a multi-asset investing podcast from Rathbones. You can listen here or whenever you get your podcasts. New episodes monthly.
