JP’s Journal: Should Have Been a Fun Manager

Fixed Income

My wife is an archaeologist. When in social gatherings her job has always garnered more interest than mine, which in noisier atmospheres is often heard as fun manager.

 

I guess programmes like Time Team and Digging for Britain has popularised archaeology, or it may be that finance is just a bit boring. After all, talk about default rates, corporate bond spreads and government bond issuance may not be riveting to many. Not surprisingly, the fun manager mishearing gets a better response.

 

Anyway, archaeologists have had a field day, literally, in recent years. They are in demand as never before to excavate and investigate along the HS2 route. Reports last week suggested that the government was planning for the track to stop short of Euston, with a terminus at Old Oak Common. Though denied, it does nothing to improve the UK’s dire record on infrastructure. With contractors warning about building material costs, the £56bn project (2015 estimate; lets double that now) is in the process of taking a significant bite out of capital spending budgets. Add in the Hinkley Point mess and you really worry whether, despite all governance processes, we have an approach fit for purpose. Please, someone, get a grip. We may aspire to be the most attractive country for investment but actions speak louder than words and our infrastructure planning and delivery tells a different story.

Data: A mixed picture

On the data front, we saw flash Purchasing Managers’ Indexes for January; they were generally downbeat but not signalling a sharp slowdown. US Q4 growth was shown to be a bit stronger than expected, although underneath some trends were weaker. Consumer spending was lower than expected and fixed investment nosedived (all due to residential weakness). Government spending was robust and inventories contributed even more strongly; the question is whether inventory build is good or bad.

 

So where does this leave the Bank of England (BoE)? Markets are still pricing for a 50bps hike, as domestic inflationary pressures are not abating and labour conditions remain tight; it is likely that the BoE will upgrade its growth forecast. Remember: last November it forecast a near 3% fall in output over the two years to mid-2024. But, better domestic data, lower implied future interest rates, an improved outlook in China and lower energy costs are all helping. However, better economic news is a double-edged sword as it makes the achievement of a sustainable 2% inflation target more challenging. The BoE was counting on a short sharp recession to dent domestic inflation. If this is curtailed, rates may have to stay higher to kill off latent price pressures.

 

I remain more pessimistic on growth than the consensus. Why? Because I see tighter monetary policy having more of an impact than is presently assumed and I worry that corporate earnings will come under greater pressure than currently forecast. If the major economies manage to skirt recession it will be an outstanding feat: to have coped with both an energy / inflation shock, and an end to near-free money without a recession would be abnormal.

Markets move sideways

Bond markets oscillated but did not really change much on the week. Yields on 10-year US government yields hovered 3.5%, although real yields fell a bit, pushing up implied US inflation. In the UK, 10-year yields moved towards 3.3% but there was low conviction ahead of the BoE rates announcement this Thursday. Similar to the US, real yields fell more, giving rise to higher breakeven inflation. In credit markets the same trends that we have seen in recent weeks continued. There remains good demand for longer dated, higher quality investment grade debt, with signs that UK pension funds are rebuilding positions. High yield spreads did not change a great deal and remain at the lower end of their recent range.

 

Our fixed income strategies continue to favour credit over government bonds, with a mild preference for shorter dated positioning in government and investment grade portfolios. With the recent pull back in interest rate expectations, yields on shorter dated credit look more tempting than government bonds, given the attractive spreads available.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.

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