MUNIX WEEKLY 22 April
April showers
April can be a lovely month as warm sunshine appears, but it is also renowned for its rain showers which can dampen the spirits. Much the same for fixed income markets this week.
The latest views from the IMF and the World Bank should have brought a warm glow to bond investors. Both downgraded their economic forecasts as finance ministers met for their spring meetings in Washington. The pandemic, China slowdown, Ukraine war, and commodity inflation all bear down on current and future economic activity. Hence, the World Bank cut its global growth forecast for 2022 by almost 1 percentage point, to 3.2 per cent, pointing primarily to the shocks from Russia’s invasion. The IMF cut its estimate by 1.3 percent, suggesting that the world economy will only grow by 3.6 per cent in both 2022 and 2023. This is so slow compared with past history that it suggests that some countries will experience recession. Indeed, the UK looks to be particularly hard hit, partly due to significant fiscal tightening of course. The Fund expects UK annual growth to slow from 7.4% to 3.7% to 1.2% between 2021 and 2023.
Truth be told the Fund may not be the world’s most accurate forecaster, but the breadth and depth of its coverage provide considerable insights into what is happening in the world economy and the likely direction in coming months. For example, the IMF paid considerable attention to the effects of the considerable accumulation of private debt, which will act as a drag on growth as households and companies prioritise higher interest payments. Notably, the US 30 year mortgage rate has risen from 2.75% past 5.25% in the past 18 months, and the housing market is already starting to roll over.
The latest hard data backed up such views. UK retail sales in March and consumer confidence in April were both on the weak side – no surprise against the backdrop of higher food and energy prices and sizeable tax increases. Indeed Reuters calculated that such low readings of consumer sentiment have presaged recession on 4 out of 5 occasions since the survey started in 1974
However, this is not new news to the bond markets. They continue to look to the inflationary element of the stagflationary environment enveloping many countries. For example, the Fed’s business survey known as the Beige Book reported that companies continue to struggle with surging prices, supply bottlenecks, and tight labour markets. Crude oil prices may have eased back towards $100 per barrel but investors pay more attention to the fast growing supply chain pressures as shipping piles up around the partially shut Shanghai port. Lagarde at the ECB admitted that EU inflation could be double the central bank’s target at year end.
Other messages from central bankers added to April’s sunshine and showers for bond investors. Fed Chairman Powell said the central bank should tighten policy a little more quickly, so “Fifty basis points will be on the table for the May meeting”. However, Governor Bullard attracted much media attention when he raised the possibility of a 0.75% rate hikeand indicated that he favours rates heading to a “neutral” rate of about 3.5% by the end of the year. He was not alone even if he was more strident. Charles Evans, Chicago Fed president, accepted that the central bank is likely to raise interest rates towards 2.5% by the end of the year. Wunsch at the ECB said he was thinking about a rate hike as soon as July, and rates at or above zero by year end. Closer to home, Andrew Bailey worries about the labour market pressures being seen in the UK. “We are now walking a very tight line between tackling inflation and the output effects of the real income shock, and the risk that could create a recession and pushes too far down in terms of inflation”. Catherine Mann also hinted at the need for a quicker pace of tightening.
Market responses were significant. The US 10 year benchmark bond yield is approaching 3%, not far from the peak of 3.25% seen in 2018. The 10-year inflation-linked Treasury yield, thatis the real interest rate, has moved into positive territory for the first time since March of 2020. As global bond yields are being dragged up, so some central banks are responding, with the Bank of Japan intervening to try and cap benchmark yields.
Recent changes in the outlook for interest rates have been dramatic. At the end of last year, market expectations for US and UK interest rates at the end of 2022 were about 0.75-1.0%. Today the market expectations for year-end are closer to 2.0-2.5%. Markets not only expect rates to rise but, in many cases, to stay higher for longer – for example speculation about three moves by the ECB this year while the terminal rate is expected to reach and stay above 1.5%.
The UK economy may be growing more slowly than some others in 2022-23 but inflation expectations have not yet peaked. Hence, the UK benchmark gilt yield has been dragged up towards 2%, which is its highest level since late 2015. Will April showers be followed by summer monsoons or radiant sunshine for the summer ahead?
Bond yields at the time of writing this week and one month change
% 2 year 5 year 10 year
USA 2.72 (+0.55) 2.99 (+0.59) 2.94(+0.56)
UK 1.75 (+0.35) 1.81 (+0.35) 1.99 (+0.27
Germany 0.18 (+0.42) 0.69 (+0.48) 0.93 (+0.44)
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making