19th September 2017

Rathbones weekly review: Bond man’s Bluff

Central bankers whipsawed gilt markets last week.

After months of downward pressure on yields, the 10-year flew from 0.99% to 1.31% in a week. A much more aggressive Bank of England (BoE) was the cause. Only two Monetary Policy Committee members voted to raise interest rates at last week’s meeting, in line with the previous month. But the meeting statement was punchy. The bank said its policy would need to be somewhat tighter than market expectations if the economy continues broadly in line with projections it made in August. It followed this up by noting that it felt economic data were actually slightly better than forecast. It says economic growth isn’t so bad, unemployment is at a 40-year low of 4.3% and labour surveys are looking bright. The BoE does note that real wage growth remains negative, inflation is likely to rise above 3%,  and personal consumption is down, but it effectively shrugs all that off.

The bank could have added that property prices have showed signs of weakness, but the UK’s largest asset market wasn’t mentioned at all. Since the statement, Rightmove house price statistics show that UK asking prices slipped 1.2% in September compared with August. In London, the monthly fall was 2.9%.

Investors are divided. Is the BoE actually ready to pull the trigger or is Governor Mark Carney trying to talk up the pound? The currency has had a miserable time lately and is flirting with parity against the euro. The hawkish tenor of the bank’s latest missive pushed sterling 2.2% higher for the week. Inflation is not at crazy levels, but it is squeezing consumers at a time when their employers are particularly reluctant to dole out pay rises or meaningfully invest to boost productivity. A stronger currency should help take the edge off rising prices.

The BoE hints at the problem in its minutes: the bank cannot fight the “necessary real adjustment” the UK must endure following Brexit or the weaker real income growth that will accompany it. The government must deliver the best deal it can for Britons and fiscal policy must enter the breach politicians have created.

All the central bankers can do is play for time.

Source: FE Analytics, data sterling total return to 15 September

The art of controlling your environment

Hurricane Harvey and Irma have caused tens of billions worth of damage to Texas, Florida and surrounding states, making them easily the second-worst US natural disaster since World War II.

Not that this weighed on American share markets at all. The Dow Jones and the S&P 500 hit record highs on Friday after inflation continued to tick up again. US inflation reached 2.7% in February before decelerating to 1.6% by June. It has since been heading back up, with last week’s reading at 1.9%. Eyes are on the Federal Reserve, to discuss monetary policy.

Even another North Korean missile test, this time in the early hours of Friday, couldn’t dent the bull run of American equities. The rocket, again, flew over Japan, but Topix investors shrugged it off too. The Japanese index jumped 2.9% in yen terms last week. Prime Minister Shinzo Abe is rumoured to be plotting a snap election after regaining popularity that had been tarnished by several scandals in his inner circle. If he has another four years, investors expect the shareholder-friendly changes to Japanese corporations to continue.

Meanwhile, German Chancellor Angela Merkel’s CDU party is set to comfortably win a plurality in Sunday’s Bundestag elections. The CDU is polling at roughly 39%, with its closest rival, SPD, on just 24%. The right-wing protest party Alternative für Deutschland  has faded since last year’s highpoint and is expected to receive about a tenth of the vote.

Emmanuel Macron, France’s new centrist President, pushed ahead with his labour market reform last week. Tens of thousands of trade unionists turned out to protest his plans on Tuesday – there were about 4,000 strikes nationwide, according to the FT. But the opposition is notably lower than when Mr Macron’s predecessor, Socialist Francois Hollande, tried to enact lesser changes to rigid employment laws.

Still, these changes are tremendously unpopular: two-thirds of France is unsure about his labour policy. More than half of the country are unhappy with Mr Macron, himself, to boot. But something must be done in the Republic. You only have to take a walk round London to hear just how many young French-speakers have flocked across the Channel in recent years. There has been much grumbling in the UK about intergenerational warfare, typically over extortionate

house prices. But in France it is beyond doubt. Unions have an iron grip on the labour market that lets their members enjoy fantastic job security, limited hours and strong pay growth. But these members are overwhelmingly old and middle-aged. Meanwhile, youth unemployment stands at 23%. Those locked out of the unionised jobs have to make do with temp contracts, low wages and precarious living.

Unions have a strong history of delivering better working conditions and ensuring labourers see a fair slice of business profits. But an unregulated monopoly is an insidious thing, and industry is not the only part of the economy where they exist. A privileged caste with a stranglehold on wealth is what unions fought against in the first place.

Bonds

UK 10-Year yield @ 1.31%

US 10-Year yield @ 2.20%

Germany 10-Year yield @ 0.43%

Italy 10-Year yield @ 2.14%

Spain 10-Year yield @ 1.61%

Julian Chillingworth
Chief Investment Officer

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