MUNIX COMMENTARY – 24th September
10, 9, 8, 7, 6, 5 – ignite engines….
The rocket is on the launchpad, the engines have been ignited, clouds of vapour appear, do we have lift-off?
Amidst a flurry of central bank meetings, economic statistics and company reports, the gilt market has at last shown a sense of direction. At 0.9% for the UK’s 10-year bond yield, the highest since May, there are signs that at long last the trading range has broken out to the upside.
The latest report from the Bank of England was the primary mover. The Bank had to join other forecasters in admitting that headline inflation could exceed 4% this winter and will continue to rise into the second quarter of 2022. Indeed the peak may be rather higher and broader once the full effects of the latest surge in natural gas prices and shortages of CO2 start to ripple through the economy. Market expectations have shifted modestly but noticeably towards a base rate increase in the first half of 2022. The turn towards a slightly more hawkish stance was also shown by the news that two of the nine MPC members voted to halt the QE bond buying programme immediately.
Other central bank meetings provided a firm foundation for this move. The Federal Reserve also updated its forecasts. Jerome Powell, Fed Chair, warned that the QE tapering process should start this autumn and be completed by the summer of next year. Rate rises would then begin, with Fed Governors projecting 3 more moves in 2023 and another 3 the following year. Although the increases have been well telegraphed, the weight of evidence about a new policy regime forced US benchmark bond yields to 1.4%, their highest since June.
It would appear that the statements from central bankers were more influential than the stream of somewhat mixed economic and corporate data seen in the past week. Various business surveys indicated a slowdown in economic activity in most countries into September, not a surprise in view of the widespread shortages of labour, key parts and raw materials. This looks to be temporary, however. The OECD has produced a new set of forecasts for the major economies, with minor upgrades and downgrades to 2021 and 2022. The net result is still above trend growth, for example the UK economy is expected to expand by 6.7% this year and 5.2% next. This helps explain why the OECD hiked its 2021 and 2022 inflation outlook for USA, the Eurozone and the UK.
What could drive bond yields higher in coming weeks, or potentially reverse the current trend? Politics is certainly a possibility. The complicated debt ceiling debate in Washington continues with no end in sight, possibly leading to a shut-down of Federal government operations. The Chinese authorities are trying to ensure a soft default for the massively debt burdened Evergrande Group, but if they fail then the second-round impact on the housing and financial sectors would be considerable. Governments have little ability to control energy prices. The recent surge in the cost of natural gas across Europe is likely to have knock on effects, not just the planned rise in household bills in October. The final issue will be investor confidence, exemplified by the balance between demand and supply of bonds. In September alone, $625 billion of new supply is expected across the US Treasury, credit and equity markets, which is considerably greater than average in recent years. Robust demand for income suggests that the upward trend in yields can be steady rather than too dramatic.
Andrew Milligan is an independent economist and investment consultant. This note should be considered 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