Monthly Commentary July 2017
The return of monetary policy
By Robert Scammell, Senior Portfolio Manager
Over the last year I have occasionally felt more like a political analyst than a portfolio manager. From Brexit to the latest French parliamentary elections, the shakeup in the previously established political order in such a short space of time has, at times, been quite un-nerving. Markets have naturally reacted to these events sometimes quite significantly. So it was with some relief that the large market moves seen in the UK and internationally at the end of last month were entirely down to good old fashioned economics.
Long-term UK nominal yields rose by 0.2% in the last week of June as the gilt market reacted to a potential change in Bank of England sentiment. Moves at the shorter end of the curve were also pronounced with 2 year yields moving to their highest level since the Brexit vote almost exactly a year ago.
The origins of this spike up in yields started mid-month with the release of the June MPC minutes. These showed that three members of the MPC voted for an increase in policy rates – the highest number of dissenters voting for a rise since the 2008 crisis – and indicated that the sharp increase in inflation may be enough to persuade the MPC to reverse the post Brexit rate cut. To use a footballing analogy the score at half-time was therefore a fairly convincing 5-3 to The Doves but the momentum was with the Hawks.
This was followed up with a speech by Bank of England chief economist Andy Haldane on 21st June saying that he too would be ready to vote for an increase in rates ‘relatively soon.’ This was seen as an important intervention potentially swaying the vote to 4-4, but with Governor Carney having the casting vote and only the previous day saying that ‘now is not yet the time’ to raise interest rates The Doves went into the final quarter with a narrow lead.
Mark Carney has earned himself the nickname ‘the unreliable boyfriend’ over the years for his seemingly constant changes of heart over the path of interest rates. Whilst this is somewhat unfair, he did his reputation no favours when, a week after saying it was not the right time to raise rates, he said ‘some removal of monetary stimulus is likely to become necessary’’. The fact is of course that this is true, and Carney’s very next sentence qualified the circumstances under which a rate rise could occur. However the markets were not interested in the subtleties. The star player had come off the bench in the final moments of extra time to hand the Hawks a last minute winner and a thrilling 5-3 victory.
“Market moves last month were down to good, old-fashioned economics”Robert Scamell, Senior Portfolio Manager
As is normal, yield moves in the UK are also influenced by events in Europe and the US. This month events in other major economies have re-enforced the perception that major central banks are looking to tighten policy.
Whilst the guidance coming from the ECB has been mixed around tapering its bond buying programme, it is clearly it is on the agenda as the euro-zone economy recovers quite strongly and the threat of deflation subsides.
The Federal Reserve in the US has already started tightening policy rates and is debating what degree of unconventional stimulus is appropriate.
Rising yields are good for pension schemes, in particularly those that have been underhedged. However this is not the time for complacency; what monetary policy gives, it can also take away. It is highly unlikely that we are going to see a return to pre-crisis levels of yields anytime soon.
30-YEAR NOMINAL YIELDS FOR SELECTED COUNTRIES: SOURCE: BLOOMBERG.
The bankers are back.
Nikesh Patel, Head of Investment Strategy
After a remarkably boring month for markets in June, things livened up in the final week of the month and quarter, as equity markets fell on less dovish speeches by central bankers in the UK and Europe.
Whilst still in positive territory for the year-to-date, most equity markets gave up some of their gains over the second quarter of 2017 – especially so in the case of the UK and Europe. Bond markets also fell as yields rose in Germany, the US and the UK; the latter being key as the principle driver of pension scheme funding performance. UK pension schemes will have received a much needed pick-me-up, the scale of which will vary depending on how (under)hedged they were. And what was behind this mini-tantrum? As the old line goes, “there have been three great inventions since the beginning of time: fire, the wheel, and central banking.”
The sudden reversal in the tide was a reflection of investors’ reaction to the change in tone from central bankers, particularly in the UK and Europe. The Bank of England’s (BoE) 5-3 vote to maintain rates at their historic lows was closer than the 7-1 vote expected; markets have begun to price in a modest increase in the chance of a rate rise before the end of the year. Suggestions that the European Central Bank (ECB) might begin to scale back its asset purchases through QE (due to inflation concerns) was received particularly badly. In both cases (and to a lesser extent the less dovish tone by the US Fed, and its toe-in-the-water approach to trimming its massive balance sheet), investors are uncertain whether markets can continue to thrive without the monetary stimulus that has so supported them for nearly a decade. It isn’t quite the “Taper Tantrum” we saw in 2013, but still indicative that investors haven’t quite decided if markets are healthy enough to live without life support. This is a reflection of both that the US is already further ahead in the process (successfully keeping investors – more or less – comfortable), and that whilst the ECB and BoE are undoubtedly important, they just aren’t as important globally as the Fed.
June was also a busy month politically, though that seems so long ago given the pace in political events! The success of Macron in the presidential and legislative elections in France was a much needed shot in the arm for the European project. This was contrasted with the rather spectacular enfeebling of Theresa May’s government being held to ransom by the Democratic Unionist Party of Northern Ireland (more on this, and implications for Brexit, in Rob Scammell’s commentary this month). And yet investors appear to have remained sanguine with little volatility around these events in the UK.
“It isn’t quite the Taper Tantrum”Nikesh Patel, Head of Investment strategy
Pension funds in the UK have generally had a good year to date, undiminished by market, political or geopolitical events, and supported by the combination of rising equity markets and modestly rising long dated real gilt yields.
Whilst the lull in volatility which has characterised the first half of 2017 is, in our view, unlikely to persist through the second half of the year, the direction of travel for central banks (and market reactions thus far) support our preference for equities over bonds (with a modest underhedge in liability hedging portfolios), and within equity portfolios a preference for value stocks as the tide of stimulus begins to ebb.
MARKET PERFORMANCE OVER THE WEEK ENDED 30 JUNE 2017: SOURCE: BLOOMBERG, IN STERLING TERMS
MARKET PERFORMANCE OVER THE YEAR TO DATE 30 JUNE 2017: SOURCE: BLOOMBERG, IN STERLING TERMS