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

David Goodman · BloombergUncertain

Samsung's record profits still fell on sky-high expectations, so the bar for AI-chip stocks keeps rising.

Samsung reported record profits, which Goodman says were not bad by any means. The share fall shows how high expectations are for the AI and chip sector. He says the bar for these companies to keep the rally going keeps rising, so good results may no longer be enough. Goodman does not say whether he expects the shares to fall or recover.

“they said they weren't bad by any means. Yeah. And it just shows you how sky high the expectations are in this sector now. So, like, the the bar to to be and to keep this going is getting higher all the all the time.”at 24:11

David Goodman · Bloomberg

French-German spread blew out on a sentiment shift rather than a clear trigger, and is spreading to Italy and Belgium.

The French-German 10-year spread rose from below 100bp in mid-September to about 150bp, a level not seen since the eurozone crisis. Goodman sees no clear fundamental trigger in the last two weeks. Past French bond sell-offs followed a political trigger such as a government falling or a budget failing, but this time a shift in perception ('France is a problem') set off selling as the default reaction. He says the weakness has spread to Italy, which has tracked France despite positive sentiment on Italy, and he is watching Belgium-Germany spreads too. He views spread contagion beyond one country as the point where the problem becomes a real one for the ECB.

“We haven't really had this time. It's almost just that there was this big vibe shift where something was like, oh, France is a problem. And as soon as that thought entered people's minds, sell in was the kind of default mode”at 5:25

David Goodman · Bloomberg

UK gilts could quickly become the bond market's focus again once the recent window of investor patience closes.

Goodman says the UK has been less vulnerable in this bond sell-off than before. Investors have given the new government a window of benefit of the doubt, and the Bank of England cancelled some longer-dated gilt sales, which reduced supply at the long end. He thinks that support is ending and the UK could quickly become the bond market's focus again. He says the budget has a narrow landing zone, and cuts that don't show the government is serious on both sides of the ledger could trigger that.

“But you can see that ending, and The UK could very quickly, like, become the focus of the bond market again.”at 17:51

David Goodman · Bloomberg

Heavy corporate debt issuance by AI-linked companies is helping push up bond yields.

Goodman links the bond sell-off to the AI buildout. These companies are issuing debt at what he calls a scary rate, and this is part of the reason yields have risen so much. He notes that traditionally bonds were safe, dull investments, and that high yields now reflect this heavy supply of corporate debt. His view is that the supply is helping push yields higher.

“all these companies are issuing debt at a kind of scary rate as well, then that is part of the reason I think that's feeding into these high yields.”at 27:56

David Goodman · Bloomberg

Rising absolute yields make high government borrowing costs a real fiscal problem for France, Germany and the UK.

Goodman argues that the spread matters less than absolute yields. Germany's 10-year yield is about 3.5%, so a spread of 150bp puts France at nearly 5%. That is a real problem for French budgets, and the high rates are hard to escape once entrenched. He ties this to the UK, where the government's interest bill has ballooned beyond anything seen before. He also notes that governments moving to shorter-term debt to ride out the storm take on rollover risk, because rates may not be lower when the debt has to be refinanced.

“If Germany was at zero, that would be fine. But Germany's at three and a half. France is nearly at five now. So that is a real problem for governments that they're having to pay these high high interest rates.”at 9:13

David Goodman · Bloomberg

UK housing slowed under rates above 5%, with transactions collapsing while prices held except in specific sectors.

Goodman argues that the rate rises that pushed interest rates above 5% did not break the economy or the housing market. Transactions fell off a cliff, but absolute house prices held up, apart from falls in specific sectors such as prime Central London. He notes that real-terms prices have taken a hit, and that earlier forecasts of 10% price crashes were far too pessimistic.

“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.”at 14:00

David Goodman · Bloomberg

Entrenched high energy prices and fading hopes of an Iran off-ramp raise second-round inflation risk and push up yields.

Goodman argues that energy prices have stayed around $100 a barrel and are now entrenched, unlike earlier in the conflict when markets hoped for an off-ramp in Iran that would let inflation fall mechanically. He is worried about second-round effects, where inflation feeds into wages and then into more inflation, and central banks respond with higher rates. That threat is what he believes is driving the rise in yields.

“we have entrenched high energy prices now. And I think there were still some hopes that there was gonna be an off ramp in in in the conflicts in Iran... it is that threat of those second round effects now that I think perhaps people are worried about”at 8:01

David Goodman · Bloomberg

After a decade of zero rates and QE, central banks lack the room and credibility to cut rates in response to this crisis.

Goodman contrasts the 2011-12 eurozone crisis, when central banks had room to act and a mandate to do so (the ECB's 'whatever it takes' closed spreads), with today. Central banks have just come off a decade of zero rates and QE, and inflation is now spiking. A central bank that cut rates now would lose credibility. Goodman argues that this makes markets doubt that central banks are serious about inflation, which pushes yields higher, so the tools that solved the earlier crisis are less obvious today.

“It's a lot harder for any bank to come out and say we're gonna cut rates because they just lose their credibility.”at 8:52

David Goodman · Bloomberg

The S&P rally is concentrated in a few AI-linked stocks, which is a concerning bubble-like risk if it reverses.

Goodman says Markets Live colleagues have written a lot about how concentrated the S&P rally is, with risk piling into a few particular things. The breadth is concerning, and charts show the pattern resembling a boom and then a bust. He notes that the rally depends on the AI buildout continuing into data centres and compute. He acknowledges that the market could keep rising, but the further the trade runs, the bigger the risk. He also says bubble warnings have been around for years.

“how concentrated the the rally in the S and P has been and that all this risk is piling into very kind of particular things and the breadth of this is is really quite concerning.”at 24:31