Correlation Without Causation, UK Budget Edition

One day on from Budget Day, and headlines have near-universally decided Rachel Reeves’s package of higher taxes and public spending was full of tricks for markets, not treats. The evidence, we are told, is UK Gilt yields’ sharp volatility as they continued digesting the news Thursday. Friends, we think this is an epic case of reading too much into volatility.

It is easy, too easy, to look at a piece of news—any news—then look at the daily market movement and presume stocks or bonds have made a specific judgment. The technical term here is correlation without causation—that is, presuming that if B followed A, then A caused B. With 10-year Gilt yields up after Reeves’s speech yesterday and again today, headlines globally have decided markets dislike the new fiscal policy and are jeering the rise in planned debt issuance.

On the surface, it seems logical. Bond markets move on supply and demand, and yields move opposite prices. So a planned supply increase, all else constant, should make prices fall and yields rise. It is all simple, freshman-level Econ stuff. (If you took freshman Econ and stayed awake, that is.)

But it is also incomplete, ignoring the fact that the UK is but one country. The question isn’t just what Gilt yields did, but what they did relative to other countries. French yields also rose Wednesday and Thursday. Were investors in French debt freaking out over higher UK borrowing? What about US Treasury yields, which rose Wednesday and Thursday morning before drifting back lower? Did Uncle Sam’s creditors panic over UK debt when they woke up? What about German, Italian and Spanish yields? Could it be that bond markets are simply global and volatile, and fiscal policy changes in one country aren’t the major driver that people think?

We can do the same exercise with stock markets. UK stocks dropped Wednesday, but so did US markets and those across Europe. When both are denominated in US dollars to eliminate currency skew, British and US stocks fell -1.91% and -1.86%, respectively.^[i] UK stocks fell a little bit further in dollar terms, but the difference literally rounds to nothingness! When both are denominated in pounds, UK stocks fell less.^[ii] When you view UK market movement in a global context, it starts looking less like a knee-jerk Budget reaction and more like a global, sentiment-driven hiccup.

Besides, this is all too short term. In the heat of the moment, markets can do any old thing, based on emotions and traders’ whims, both fickle. In the longer term, they move on the gap between reality and expectations. One handy thing about the UK Budget freakout? It sets expectations exceedingly low. The Guardian ran a helpful snapshot of this Thursday, highlighting every major UK paper’s reaction. Headlines included phrases like “horror show,” “nightmare” and “bombshell.”^[iii] We aren’t saying the spate of tax hikes and public spending is some economic panacea—we largely agree with the analysis expecting higher business taxes to be a modest headwind, and higher spending probably isn’t a perfect counterbalance given the inherent inefficiencies. But this is a well-known viewpoint, and when the sentiment bar is so low, it doesn’t take much for reality to beat expectations. In this case, with analysts across the political spectrum seeing this Budget as an unproductive return to mid-century policy and economic malaise, if not outright doomsday, a reality that just kind of plods along would probably be a relief.