Monday Digest
Posted 1 December 2025
Markets give thanks to central banks
Capital markets had a good week. Headwinds are abating and optimists see a Santa Rally building, while pessimists see only markets not going higher.
We talk more about the UK budget below, but in short, markets took it well. Significant capital came out of UK portfolios in anticipation of wealth tax changes that never came. If that returns, it’ll boost UK assets. We also note that international investors see the UK as a better destination than many Britons. With the budget over, the government can issue more bonds and it’s skewing issuance towards the short end – taking pressure off long-term yields. Yields are also helped by the Bank of England’s likely interest rate cut in December.
Yields fell in most markets, thanks to a dovish Federal Reserve. Fed officials are still divided, but the dovish members are getting more airtime and recent consumer weakness has pushed the implied probability of a December cut up to 80%. The ECB is also split, but recently weak economic data suggests it will cut rates next year. Japan and China are the outliers: the BoJ disagrees with Prime Minister Takaichi’s wish for yen weakness, and Beijing is intent on pushing its own currency higher. That’s surprising, given China’s weak economy, but renminbi strength is more about status than economics.
US monetary policy is looser and the government reopening means its money will flow into the system again. This improves liquidity, helping risk sentiment. The good mood has spread beyond the big tech names – with smaller companies benefitting more from upcoming rate cuts. For most of the year, retail investors were bullish and institutional investors were nervous. Now, those roles have flipped: retail fears an end to the three-year bull market, while institutional investors see strong earnings, supportive policy and strong AI capex. This could create a capital rotation to the lesser loved stocks – as institutional investors tend to prefer a bargain to the momentum factor. That broadening of the market wouldn’t be a bad thing.
Don’t bet against the budget
The Office for Budget Responsibility’s (OBR) accidental early release of its assessment was an appropriate finish to a leaky autumn budget buildup. We’ll keep our analysis to how the budget might affect UK growth and assets.
The budget aims to raise £26bn in extra revenue, with the biggest share coming from a freezing of income tax bands until 2031. The tax take will be delayed; no rises now but higher real (inflation-adjusted) costs later on. Other measures include a raid on pension contribution tax breaks and higher dividend taxes, while there was some relief for benefits and small businesses. The OBR now predicts £22bn fiscal headroom for Chancellor Reeves, but downgraded its 2026 UK growth forecast to 1.5%.
Markets considered this a decent growth-deficit compromise. Gilt yields were volatile on Wednesday – falling on the OBR’s early release then rising on fears of delayed fiscal consolidation (and the possibility the government might later cave on fiscal discipline). Yields ended the week significantly lower, proving the OBR’s mishap was much ado about nothing. The fact stocks rose and sterling strengthened proved markets approved, on balance.
We’ve written about the UK market’s liquidity problem before, and on the face of it you would think pension raids and dividend taxes might exacerbate it. But higher dividend taxes will likely encourage share buybacks. These are systemically liquidity-neutral but can be an important source of short-term liquidity.
Because UK investors aren’t lately heavily investing in their own assets anyway, Britain’s markets are more sensitive to international investor sentiment, which tends to be more positive than domestic sentiment. For international asset holders, the government’s aim of getting interest rates down and containing the deficit is a positive. It hasn’t been a smooth ride, but the market reaction suggests the Chancellor is getting there.
US earnings: supportive or overexcited?
Almost all S&P 500 companies have reported Q3 earnings, and the blended average shows 13.4% year-on-year growth. The ‘Magnificent Seven’ tech stocks posted their lowest growth since Q1 2023, but the 18.4% profit expansion is still higher than the rest of the index. Future earnings forecasts show an acceleration for the Mag7. There’s life left in the AI boom yet.
Other American companies have closed the gap, with the so-called S&P 493 (500 minus Mag7) comfortably beating expectations to post 11.9% growth. Many thought the last quarter would be tough, with looming tariffs and unhappy US consumers, so the earnings beat is welcome.
Q4 looks tougher for the S&P 493, with only 3.4% year-on-year growth expected. It’s a crucial time for retailers, as tariff and consumer spending doubts remain. It was also the quarter of US government shutdown, hampering economic activity. We could get another surprise, though. Companies usually lower their earnings guidance to generate an earnings ‘beat’ and boost their share price – but that didn’t happen for Q3. Analysts downgraded forecasts after ‘Liberation Day’ but then many companies stopped issuing guidance altogether, so forecasts stayed static. We wondered if that sapped potential for a ‘surprise’ but Q3 delivered one anyway.
Q4 and Q1 2026 forecasts haven’t moved much either – perhaps because tariff effects are still uncertain and the government shutdown has prevented data releases, or perhaps because analysts are fed up of the old ‘downgrade and beat’ routine. It’s hard to know what the static forecasts mean: are companies more resilient than expected, or will future earnings not beat as usual (or perhaps even disappoint)? If Q4 earnings came in as they are forecasted now, it would be weaker than recent quarters. That would certainly add to the current ‘AI bubble’ fears. Fortunately, there’s not much evidence that will happen in the earnings reports themselves. Overall, it’s been a good earnings season for investors.