Sam Benstead breaks down the latest news affecting bond investors.
Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.
Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.
Here’s what you need to know this week.
Bank of England raises rates again
Interest rates rose this week from 3.5% to 4%, a move that was anticipated by financial markets. The Monetary Policy Committee voted 7 to 2 to increase the bank rate by 0.5 percentage points.
The Bank of England said: “Global consumer price inflation remains high, although it is likely to have peaked across many advanced economies, including in the United Kingdom.”
But the Bank expects annual CPI inflation to fall to around 4% towards the end of this year, from 10.5% in December.
It noted that markets expect rates to hit 4.5% by the middle of 2023 before falling back to 3.5% in three years' time.
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The S&P 500 has risen 8% in dollar terms this year, while the FTSE All-Share is up 4%. Part of the reason for the rally is that investors think inflation has peaked, and central banks are close to ending interest rate rises.
Hussain Mehdi, macro and investment strategist at HSBC Global Asset Management, says the bank rate is now near its peak interest rates, but high rates may do damage to the economy.
“The big question is now the speed in which the Monetary Policy Committee can reverse course on rates. A downside risk for markets and the economy is a long period of restrictive policy to deal with persistent underlying inflation.”
Mehdi is therefore cautious on UK and European stocks in the face of downside risks to the economy and corporate earnings growth, relative to market expectations, and believes the recent rally to be unsustainable.
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Another pessimist on the UK is Vivek Paul, UK chief investment strategist at the BlackRock Investment Institute.
He says the damage to the UK’s real economy is only starting to be seen as the effects of the rate hikes are lagged, so the recent near-term growth resilience should not be extrapolated.
Paul said: “Inflation is set to fall but, in the long run, will remain above the Bank of England’s target as supply shortages prevail. High vacancies, low productivity, ageing demographics, and falling forecasted net migration suggest real challenges ahead for Britain.”
This means that stock market investors should look for opportunities elsewhere, according to Paul.
“Emerging markets have a comparatively better backdrop in the near run as rates peak and China reopens. We remain cautious on UK gilts, preferring short-term US government bonds and investment-grade credit that offer some of the highest yields in the last two decades,” he said.
US interest rates also rise
The Federal Reserve in America also raised interest rates this week, from a range of 4.25% to 4.5%, to 4.5% to 4.75%.
Inflation in the US is falling faster than in Britain. Its December print was 6.5%, down from 7.1% in November.
While the quarter-point rise was expected, markets rallied following comments from central bank boss Jerome Powell, even though he said that he does not expect to cut rates this year, which is contrary to what bond markets are indicating.
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Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, said: “During the press conference, chair Powell indicated that further work needs to be done despite the broadening disinflationary trend.
“We think the terminal (peak) rate is likely to be around 5.25% and today’s meeting certainly signals in that direction. The strength in the labour market remains at odd with dynamics in housing and signals from business surveys, which indicate an elevated risk of a recession.”
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