When France and Germany pay for deficits, fiscal discipline becomes a "moat" for the UK bond market, and investors position early for a gilt rebound.

Note that some large investors are betting that UK Chancellor John Healey will stick to fiscal discipline in his first budget, thereby triggering a rally in gilts (UK government bonds). M&G, Ninety One, Mediolanum International Funds and Raymond James Wealth Management have bought UK government bonds ahead of the October 28 budget, betting that yields could fall if Healey demonstrates a steady hand on spending and borrowing. Moyeen Islam, UK rates strategist at Barclays, said: "For a new chancellor facing an uncertain backdrop, delivering a boring budget may, from a bond market management perspective, be precisely the best outcome. With global markets focused on Washington, Paris and Tokyo, Healey should not give the market a UK-specific narrative to latch onto." UK borrowing costs are the highest among comparable countries With 30-year yields at 5.8% and UK borrowing costs higher than in peer countries, Healey's task is to uphold fiscal guardrails while setting out Prime Minister Andy Burnham's tax and spending policies, and to avoid the kind of "creative accounting" that would infuriate the bond market. Recent history shows that once investors lose confidence in a government's plans, a sharp adverse reaction can follow. Max Kettner, chief multi-asset strategist at HSBC, is bullish on gilts ahead of the budget, especially long-duration issues, arguing that investor concerns are already fully priced in. Among comparable developed-market sovereign bonds, this is the only one he recommends buying. According to UBS strategists, if the budget lands smoothly, 10-year gilt yields could fall by as much as 20 basis points, or 0.2 percentage points. Jason Borbora-Sheen, a fund manager at Ninety One, has added to long-duration gilts this year, arguing that the market has already "been through the fire" and that the new government has shown "a degree of orthodoxy, or concern about how gilts will react to policymaking." The UK has spent years paying the price in the bond market for thisin 2022, then-Prime Minister Liz Truss unveiled large deficit-financed tax cuts in a "mini-budget," and the resulting market turmoil was so severe that she abandoned most of the measures, fired her chancellor and resigned after just 44 days in office. Since then, investors have responded to any sign of fiscal profligacy by pushing bond yields higher. And in recent years, chancellors, eager to keep borrowing costs as low as possible, have sought to convince the market that they will abide by fiscal rulesnamely, that the government may only borrow to invest, and that net financial debt must fall within a rolling three-year forecast horizon. Chris Jeffrey, head of macro strategy at Legal & General, said these guardrails set clear limits on how much the government can borrow and how large the debt can grow. He said this discipline "frankly does not exist in the US," and that in parts of Europe the rules are far fuzzier. "I think the institutions the UK has built to entrench sustainable fiscal policy are working," Jeffrey said. The International Monetary Fund (IMF), which bailed out the UK during its currency and debt crisis in the 1970s, has warned Healey to use cost-of-living support measures "with restraint," or risk reigniting inflation. But IMF chief economist Silvana Tenreyro also said that among the G7, the UK stands out for budget plans that "stabilize debt" and are steadily bringing public finances back under control. This may be starting to change the narrative around UK debt. In July this year, on Burnham's first day as prime minister, gilts sold off after he said he would seek "any flexibility" while abiding by the government's borrowing and spending rules. Last year, Burnham complained that the UK "owed" the financial markets, then retracted the remark. Since Burnham was elected as an MP, market attention has shifted elsewhere More recently, Burnham's adherence to fiscal rules has helped calm market nerves, and investors have turned their attention to other markets. Since Burnham was elected to parliament on June 18, clearing his path to Downing Street, the UK 10-year yield has risen by about 0.6 percentage points; over the same period, comparable French bond yields have risen by more than 1 percentage point amid political and fiscal concerns. "The rise in UK long-term government borrowing costs over the past year has been driven mainly by changes in central bank policy rate expectations, rather than by a change in views on the risk of holding UK government bonds themselves," Islam said. Still, some investors believe the UK faces major challengesthe country has weak economic growth and is beset by inflation pushed up by the war in the Middle East. David Zahn, head of European fixed income at Franklin Templeton Investment Management, said the government is effectively "buying more time to come up with a plan," because Burnham's Labour Party has "no interest" in cutting spending such as welfare. "They are playing for time, hoping something will turn up to solve the problem," he said. But for now, with France in the spotlight and US debt levels drawing more attention, the budget has gone from a potential "stumbling block" to a potential "positive." "The UK's advantage right now is that it is being ignored by the market, and keeping it that way is, arguably, precisely the chancellor's job," Islam said.