MUNIX COMMENTARY – 30th September
Small pebbles can cause a landslide.
A few pebbles shift, a rock moves, a scree slips, the side of the hill starts to slip alarmingly.
Bond yields are moving noticeably higher, and bond prices are moving lower, as gravity finally catches up with rather expensive assets. The UK 10-year gilt yield has just breached 1%, its highest level since spring 2019 – a stark contrast from the trough of 0.2% seen at the start of the year. The UK is far from alone with this experience – benchmark yields in Germany and the USA are their highest since the summer. Indeed, in September the US bond market has witnessed the sharpest rise in yields since March.
As ever when the markets move, there are a variety of explanations about why investors are reassessing the situation. Three make a lot of sense in relation to fixed income markets in the month of September – a steady series of central banker statements, then more recently worries about inflationary pressures and deteriorating politics.
Over the past few weeks, there has been a plethora of speeches from central bankers around the world, generally warning that monetary policy would need to be tightened at some point in the future. Fed Chairman Powell recently repeated again that he still thinks inflation is transitory but if that is wrong the bank will be willing to hike rates. Closer to home, Andrew Bailey’s speech to the Society of Professional Economists was worth reading for three reasons. Firstly he repeated that the Bank was likely to tighten policy in 2022 in order to ensure it met its objectives. Secondly, he made it clear that in-depth analysis of the labour market, details concerning vacancies and employees on furlough and underlying wages, would be pored over by the Bank’s economists to help determine how quickly interest rates should rise. Lastly, he emphasised that few of the issues currently troubling consumers, businesses and politicians were amenable to central bank actions. In other words, a lot of inflation being seen in the world around us was due to demand or supply shocks, not amenable to changes in monetary policy.
Top of the list would be the surge in natural gas prices, a global phenomenon caused by a complicated interaction of climatic changes, low storage levels, and Russian unwillingness to export more gas. On top of this, supply shortages caused by a lack of tanker drivers, other HGV drivers, or the back-up of container ships outside many ports around the world, are all causing disruptions across many sectors. Staffing pressures are being seen in various industries, exemplified by 1 million vacancies reported in the UK. The peak in UK inflation increasingly looks likely to be 4-5% a year in the winter, as the second-round effects from higher energy costs have their effect.
American politics are also causing market worries. Without going into all the intricacies of the debates in Congress, in effect the Republicans and the Democrats are trying to paint the other party into a corner about whether and when legislation will be passed to raise the ceiling on how much debt the US Treasury can issue. The Treasury Secretary Janet Yellen has warned that the federal government will run out of cash on October 18th, although in practice technical measures mean mid-November is more likely. Not surprisingly, global bond investors dislike the idea of politics bringing the world’s most important government to a halt.
When will the rocks stop sliding down the hillside? If share prices continue to fall on worries about Chinese growth and a squeeze on future profits, then there may be a switch into safe haven bond assets. As bond yields move higher – now 1.5% on US 10-year debt, 2% on 30-year bonds – then local and overseas demand may start to be seen. Income matters for many long-term investors, while pension schemes are looking to de-risk portfolios. The more pessimistic an investor is about the inflation outlook, however, the more they will consider that today’s bond yields are not yet giving them enough protection.
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