Interactive Investor

Bond Watch: why US inflation is falling faster than UK inflation

13th January 2023 10:51

by Sam Benstead from interactive investor

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Sam Benstead breaks down the latest news affecting bond investors.

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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.

US inflation keeps falling

The most important piece of economic data investors are watching currently is the inflation level in the US.

The actions of the US Federal Reserve, America's central bank, influence how other central banks behave, and price changes in the US are seen as a sign of what prices will do in other parts of the world.

Investors rejoiced that inflation for the year to December was 6.5%, down from 7.1% in November, and the sixth consecutive monthly drop in the inflation print.

While stock and bond markets barely moved yesterday when the data was released, the S&P 500 has rallied 4% since 1 January in anticipation of a drop in the inflation number. The 10-year US bond has dropped from a 3.75% yield at the start of the year to 3.5% due to higher bond prices.

Gurpreet Gill, global fixed income macro strategist at Goldman Sachs Asset Management, said the key thing to pull from the data was that goods and service prices pulling inflation down, while housing costs were taking longer to adjust.

She said: “The trajectory of inflation for services other than housing is the most important. Given wages are the largest cost in delivering services, rebalancing of the labour market to temper wage growth—or sharp gains in productivity—will be key to placing inflation on a sustainable downward path.

“To that effect, December’s US employment report trended in the right direction, showing a muted monthly gain in average hourly earnings.”

Another investor seeing positives in the inflation figure was Hugh Grieves, fund manager of the Premier Miton US Opportunities fund.

He said: “While the year-on-year inflation figure remains high, in aggregate prices have been flat now for the last six months, which will be a source of huge relief to the Federal Reserve. It will likely lessen the need for many more painful interest rate rises and hence dramatically reduce the risk of the widely-expected US recession.”

But UK inflation may be stickier

While US inflation has continued to drop, much to the excitement of stock and bond investors, the jury is still out on UK inflation.

November inflation was slightly below the October level, at 10.7% versus 11.1%, but additional progress may be slow to achieve, notes Frédérique Carrier, head of investment strategy for RBC Wealth Management.

“Wage pressures continue, fostered by widespread strikes. In the spring, the lifting of the energy price caps will likely also mean higher energy bills, even as wholesale natural gas prices come down. RBC expects 2023 inflation to settle at 7.3% by year end, before falling to 2.1% a year later,” she said.

She therefore reckons that inflation will be stickier in the UK than the US, which is bad news for the economy, corporate profit margins, and bond prices as the Bank of England may be forced to keep interest rates higher for longer.

RBC forecast that by November this year UK inflation will be running at 7.3%, while US inflation will be at 3%.

Nevertheless, UK shares have made a solid start to the year, with the FTSE 100 now up 4% in nearly two weeks. The yield on the 10-year gilt has fallen from 3.6% to 3.3%, a result of bond prices increasing.

Data on the UK economy today showed that GDP expanded 0.1% in November, a stronger than expected performance, which may increase pressure on prices and force the Bank of England to act more aggressively.

The next interest rate decision is due on 2 February. The December inflation figures is released on Wednesday next week.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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