Huw Pill, chief economist at the Bank of England, has described the outlook for UK interest rates as probably being more ‘Table Mountain than the Matterhorn.’ Table Mountain sits behind Cape Town and from a distance appears to have a perfectly flat top.
Whether ‘Table Mountain’, or ‘higher for longer’, the last ten days have seen an alignment in outlook from the major central banks, to much the same position. It is shared by the Fed, the Bank of England, the ECB, the Swiss National Bank and countless other central banks. They are all close to ending their rate hikes and are forecasting a prolonged pause to follow as they continue to squeeze out inflation.
Central banks can afford a long pause. The things that often force sudden cuts in interest rates, such as a financial crisis or sharp recession, are not on the horizon. But the longer the pause, the greater the risk of such a shock emerging.
Investors should maintain a diversified portfolio of stocks, bonds and alternative asset classes. The risk of policy error by central banks, either maintaining interest rates too high, for too long, or cutting rates too soon, remains.
Oddly, the commitment by the central banks to squeeze inflation resulted last week in higher sovereign bond yields, across the yield curves.
Why should 10-year Treasury and the bund yields rise in response to the thought of a prolonged pause of peak interest rates over the coming years? This surely increases the chances of inflation returning to target levels, and the possibility of recession in the process. Don’t sovereign bond investors like few things more than a recession, that brings down demand and prices, and so helps maintain the real value of a bond’s coupons and capital?
Perhaps bond yields rose because the central banks have left the door open for further rate hikes, should they prove necessary. But any further rate hikes are likely to be modest. And while such fears might move short-dated yields higher, longer-dated shouldn’t be hurt by a demonstration of serious intent against inflation.
Could it be that fear of over-supply, and/or of a Moody’s downgrade of U.S. Treasuries, is contributing? Or, are bond markets unnerved by something completely different. Perhaps a reading of the central banks’ ‘higher for longer’ position as a confirmation of a stagflation problem, as the post-Covid economic cycle lingers on, and on?
Higher Treasury yields that then push yields up elsewhere, as investors sell bunds, JGBs, etc., to take advantage of higher Treasury yields.
Stocks fell, more predictably
Perhaps more understandable, global stocks fell last week on the prospect of a prolonged pause in interest rates at peak -or near peak-levels.
Such a scenario increases the risk of recession, a hit to company earnings, and pushes out the start of the next economic cycle. Higher for longer interest rates raise the relative attractiveness of cash and bonds compared to equities.
Weak sterling to persist?
Last week’s surprising UK inflation numbers no doubt contributed to the Bank of England’s decision (albeit by a fine margin) to hold interest rates.* Core inflation fell from 6.9% in July to 6.2%, the sharpest fall in the index since it was started in its current form in 2005.
The pause on interest rates by the Bank negatively affected sterling. The pound had already been giving back gains made during the rally from March to July, when it topped $1.30 briefly, and ended last week at $1.22. The investment banks HSBC and Nomura are both pencilling in possible falls to $1.18 by the end of the year. **
Of course, there are always two parts to a story of changes in foreign exchange rates. The U.S. economy looks like it will survive the interest rate cycle with only a slight downturn, at worst. Many economists forecast a soft landing (and the Fed’s own economist forecasts suggest as much, though Jay Powell refuses to use the term). This is supporting the dollar.
All the major currency blocs might see higher for longer interest rates, but the USD is likely to also be a desirable currency thanks to the relatively strong growth of the American economy over the coming two years, that will attract investment capital.
The same inflation numbers contributed to a rally in the UK gilt market last week, bucking the trend of other major bond markets. The Financial Times*** reports that hedge funds are unwinding their short positions in gilts, believing that interest rates and gilts yields may have peaked. Indeed, given the weak UK economic growth projections, and the base effect of inflation data, further falls in inflation are on the cards.
But the headline rate of 6.7% remains high (the highest in the G7). Pay growth of over 8% per annum, together with sharp rises in petrol costs, may yet lead to a resurgence of inflation and further hikes from the Bank of England. It is surely too soon to take comfort in UK government securities.
Ready to find out more?
At Brite Advisors USA, we work with UK ex-pats all over the USA on their investment needs, both retirement and non-retirement. Our US-based advisory team seeks to provide an outstanding experience for all clients.
We facilitate UK pension transfers using UK Self-Invested Personal Pension Plans (“SIPP”) provided by UK-regulated pension trustees for clients who want to save for their retirement by taking advantage of potential stock market growth.
Contact us today to find out more.
- No Investment Advice: This financial commentary is for informational purposes only and is not intended to be, and should not be, construed as an offer to sell or a solicitation of an offer to buy any security or financial instrument or invest in any equity or investment strategy. It should not be used to form the basis of any investment decision.
- Investment Risks: There are risks associated with investing in securities and past performance is not indicative of future results. Always seek professional advice before investing. Investment suitability must be determined individually for each investor and any financial instruments/strategies described in this financial commentary may not be suitable for all investors.
- Not Legal/Tax Advice: This financial commentary is not intended to be, and should not be construed as, legal, regulatory, tax, or accounting advice. Always seek professional advice and consult with your legal counsel, tax and accounting advisors when contemplating any course of action.
- Third-Party Websites: This financial commentary may contain or reference links to websites operated by third-parties. These links are provided as a convenience only. Such third-party websites are not under the control of Brite USA and Brite USA is not responsible for the content of any third-party website or any link contained in a third- party website. Brite USA does not review, approve, monitor, endorse, warrant, or make any representations with respect to third- party websites. Brite USA is not responsible for the information contained in such third-party websites or for your use of such third-party websites. Access to any third-party websites is at your own risk.
- Brite USA does not provide tax advice. To the extent this financial commentary mentions or references any tax matter, it is not intended or written to be used, and cannot be used by the recipient or any other person, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party the matter addressed herein. Please consult an independent tax advisor for advice on your particular circumstances.