It wasn’t supposed to be like this, says Brian Tora. Why have gilt yields been falling?
The last few weeks have proved interesting for investors. Geo-political issues, most notably the problems between Russia and Ukraine, have led to something of a rollercoaster ride for equity investors. But no real sell-off had yet transpired by the time we got into the closing days of April, and it has become clear that, once shares fall sufficiently far, buyers will emerge.
De-Risking
But there has been a degree of de-risking, as the fall in government bond yields attests. With all the economic indicators suggesting that the prolonged period of very low interest rates may be coming to an end, it is hard to see why investors should be piling back into bonds, other than for the purpose of adding more secure assets to their portfolios at a time of international uncertainty.
In the UK, unemployment has actually fallen below the 7% level that the new Governor of the Bank of England once said would be the trigger for a rate rise. (Of course, when the possibility that jobless numbers would soon fall sufficiently, he was quick to change the rules. So much for forward guidance.)
Sterling is also telling us that the market is anticipating an interest rate increase. The pound has been on the up, supported by an apparently improving economic position. Even our borrowing is coming down, although we do remain the second most highly geared nation amongst the world’s richest. Only Japan has succeeded in pushing debt levels up higher.
A Puzzle
But if foreign exchange markets are factoring in dearer money, the gilt edged market certainly isn’t. UK gilts outperformed domestic equities during the first quarter of this year, rising modestly, compared with a small fall in the FTSE 100 Share Index.
Why was that? Perhaps investors feel able to take comfort from the continuing decline in the rate at which our cost of living is going up. Wage rises may now have risen faster than inflation – just – but there is little evidence of any real upward pressure on the country’s pay packets.
Despite a brighter economic future emerging, few forecasters are expecting interest rates here to go up ahead of next year’s general election. Not only is the global financial picture remaining fragile, but there continues to be a lack of trust in the sustainability of our own progress. Europe remains in the doldrums, while any disruption to energy and fuel supplies brought about by Russian action is hardly conducive to further GDP growth.
But I remain a glass half full merchant, so I find it hard to whip up enthusiasm for gilts, even if interest rates may take some time to approach the levels that we used to see. For rates to shift above 3%, we would need to be seeing either more robust growth or else some signs that inflation is lifting off again. It is hard to see either event taking place in the foreseeable future- although it is wise to remember that forecasting likely outcomes is never easy.
Your Move, Mr Carney
Still, the longer the news on the economic front remains positive, the closer a rate rise comes. With luck (don’t forget, there are those for whom an increase in interest rates will prove good news) the Bank of England may feel able to start what is likely to be a prolonged period of lifting rates to a more realistic level by the middle of next year. What effect this might have on house prices is hard to gauge.
At the end of last month the government brought in new measures to curb indiscriminate lending, making it harder for some people to borrow. It is too early to determine whether this alone will slow the rise in the value of residential property, but it is looking increasingly likely that next year could prove an important inflexion point for a number of investment asset classes.
Brian Tora is an associate with investment managers, JM Finn & Co
