UK markets hold steady as gilts slide and defence stocks surge

FTSE opens cautiously as traders eye Fed decision

​UK stocks edged higher on Monday, with the FTSE 100 up 0.2% and the FTSE 250 gaining 0.1%. The muted start reflects broader European hesitancy ahead of this week's Federal Reserve (Fed) decision.

​The cautious tone mirrors moves across continental markets, with investors positioning defensively. Traders are weighing central bank policy expectations against persistent economic uncertainty, creating a wait-and-see atmosphere.

​Trading platforms showed limited volatility in early dealing, suggesting most participants prefer to remain on the sidelines. With the Fed decision looming, conviction remains scarce across both equity and fixed income markets.

​The measured opening follows a period of heightened uncertainty, as economic data sends conflicting signals about the UK's trajectory. This creates a challenging environment for traders seeking clear directional plays.

​UK gilts weaken alongside European debt

​UK government bonds slipped across the curve, falling around three basis points as weakness spread through European debt markets. The move followed comments from European Central Bank (ECB) official Isabel Schnabel, who signalled comfort with current market pricing for a rate hike.

​The sell-off suggests the ECB remains focused on tackling inflation, even as growth concerns mount. This hawkish stance has rippled through European bond markets, dragging UK gilts lower despite different domestic conditions.

​Recent strong demand from Japanese investors provided only temporary support. October saw the biggest Japanese buying of UK debt since 2020, driven by rising expectations for Bank of England (BoE) rate cuts.

​However, those bets now look less certain given persistent inflation pressures. Japanese funds also offloaded French and German bonds during the same period, suggesting a tactical rotation rather than a broader vote of confidence.

​Defence stocks extend extraordinary multi-year rally

​BAE Systems and Babcock International continued their relentless march higher, with gains of 180% and 278% respectively since early 2022. Analysts still see room for further upside, forecasting another 24% for BAE and 12% for Babcock.

​The surge reflects a fundamental shift in government priorities following Russia's invasion of Ukraine. Defence spending has become politically untouchable, providing a powerful tailwind for UK defence contractors with established capabilities.

​But the sector's optimism is tempered by growing frustration over contract delays. Industry leaders warn that unclear timelines and a lack of long-term investment plans risk slowing progress, even as demand accelerates.

​The newly announced 'Atlantic Bastion' projects offer some near-term promise, moving toward limited contracts. However, military chiefs have warned that without funding secured beyond 2027, the UK's strategic ambitions may need scaling back.

​This creates an uncomfortable tension for traders: strong recent performance versus uncertain long-term prospects. The government's 130-page defence review, while ambitious, has yet to provide the financial roadmap the sector needs.

​Corporate movers dominate individual stock action

​Unilever rose despite spinning off its ice cream division, which began trading below its reference price as Magnum Ice Cream made its market debut. The consumer goods giant's 3.1% drop in European trading weighed on the broader STOXX 600.

​Kainos jumped 7.5% following an analyst upgrade, while Mears gained ground on robust trading updates. These gainers demonstrate that positive company-specific news can still drive meaningful moves in the current environment.

​The standout laggard was SEIT, which tumbled more than 17% as valuation pressures caught up with the stock. This sharp move serves as a reminder of the risks facing richly valued shares.

​These divergent moves underscore the stock-picking environment traders face. Broad market direction matters less than company-specific catalysts, creating opportunities for those who can identify winners and avoid potential pitfalls.

​Mixed economic signals complicate Bank of England outlook

​Starting pay for permanent staff climbed at the fastest pace in five months, according to recruitment data. This suggests the labour market retains strength despite broader economic weakness, keeping wage inflation pressures alive.

​But the housing market tells a different story, particularly in London. Mansion tax plans are expected to drive a 5% drop in high-end property values next year, signalling softer consumer spending ahead.

​These contrasting signals make the BoE's job harder. Wage growth remains sticky, complicating the case for aggressive rate cuts even as property market weakness hints at economic fragility.

​For traders, this creates uncertainty around the BoE's next moves and weighs on sterling positioning. The lack of clarity on the policy path ahead makes it difficult to take confident directional bets.

​Global backdrop remains cautiously constructive

​Asian equities traded higher overnight, while US futures firmed as markets anticipated a Federal Reserve rate cut this week. Tech shares rebounded modestly, though veteran strategist Ed Yardeni recommended underweighting the Magnificent Seven.

​European industrials and healthcare stocks provided some support, limiting losses on the STOXX 600 despite the drag from consumer staples. The overall tone remains one of cautious optimism.

​Investors are positioned for central bank easing but remain wary of potential disappointments. This creates a challenging backdrop where markets can rally on dovish central bank signals but remain vulnerable to hawkish surprises.

​The absence of major economic releases today means attention will remain firmly fixed on positioning ahead of the Fed. Any unexpected shifts in tone could trigger sharp moves across asset classes.

​What it means for traders

​UK markets are treading water ahead of the Fed decision, with both equities and bonds showing limited conviction.

​The gilt sell-off bears watching. If European bond weakness persists, UK yields could rise further, potentially weighing on rate-sensitive sectors like property and utilities. Traders should monitor any shifts in BoE rate expectations.