Investment Comment
30th September 2022
Morecambe not Wise
After the Great Recession in 2007-08, the policy enacted was to impose austerity which resulted in falling economic growth rates and a decline in interest rates. Faced with soaring inflation the new Chancellor imposes unfunded tax cuts and increased borrowing. To paraphrase Eric Morecambe’s response to Andre Previn “All the right policy, but not necessarily in the right order”. As a result of the Chancellor’s actions markets have lost faith in the policy backdrop. Sterling has fallen sharply against the US Dollar and even against the Euro in recent weeks, and events in the Gilt market are akin to the banking crises of 2008, albeit in a more opaque manner.
Sterling has been the weakest of the major currencies this year versus the US Dollar, exacerbated by events over recent weeks
Source: Bloomberg
Q-turn?
On Wednesday, the Bank of England had to step in to prevent financial contagion due to the sell-off in the UK Gilt market. An example of the scale of the destruction of value, is that the 2073 gilt which was trading at £90 in January, had fallen to around £70 by the beginning of August. At the market low on Wednesday this Gilt had fallen to £32.
The sell-off had resulted in defined benefit pension funds finding themselves in financial distress. Briefly, these pension fund issues are a result of leverage and the pace and scale of gilt price change. In the same way the regulator had allowed the banks to become too risky (and therefore in need of a bailout in 2008) the regulator has enabled pension funds to hold derivative positions that proved to be untenable given recent moves.
The Chancellor is being fiscally free and stimulative, despite the elevated inflation. The Monetary Policy Committee of the Bank of England is in the process of increasing interest rates to control inflation. And after Wednesday the Bank of England Financial Policy Committee decided to resume Gilt buying to ensure financial stability, despite the intention of the Bank of England to start Quantitative Tightening alongside interest rate increases. The current policy mix is unsustainable, in our view.
In 2008 and 2020, the Bank of England’s bond buying activity was coordinated with other central banks. Currently, the Bank of England is engaged in money printing (which is what bond buying entails) in isolation. This leaves Sterling at risk of further declines, which in turn would typically result in more inflationary pressure. To counter the inflation, the Bank of England may be required to raise interest rates higher and faster than previously anticipated. Higher interest rates in turn will lead to a harder recession. So, the Chancellor’s and Government’s ‘Growth Plan’ may fall at the first contact with reality.
One consequence of higher interest rates from the Bank of England and the move in bond yields has been the withdrawal of mortgages by banks and building societies. This is likely to slow the pace of housing market activity. A change in the mortgage market over the past two decades means that the actual impact of interest rate increases will be delayed. Over 80% of existing mortgages are fixed, with about two-thirds of these being fixed for five years or longer. So the rise in interest rates will take effect when the shorter dated mortgages mature. UK Finance, the trade body, estimates that 1.8 million people will see their mortgages elapse in 2023. These may have been fixed at under 2% and may face interest rates of 4-4.5%. Alongside the cost-of-living crises, households may be facing an unwanted increase in mortgage costs.
Whilst events in the UK have understandably been in the headlines, elsewhere the US earnings season is about to start. These may reflect the slowdown in activity seen over the summer, and we will be watchful about the commentary and guidance around profit margins which remain elevated. If profit margins fall then there is an increased risk of lower than expected corporate profits and downside to equity markets.
Gerard Lane Chief Investment Officer
Artorius provides this commentary in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 30th September 2022 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
The value of investments and the income from them could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance of an investment or asset class is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice.
Reliance should not be placed on the information contained within this document when taking individual investment or strategic decisions.
Any advisory services we provide will be subject to a formal Engagement Letter signed by both parties. Any Investment Management services we provide will be subject to a formal Investment Management Agreement, which will include an agreed mandate.
Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
We may update this information at any time without reference to recipients.
FP 20220929001 Exp 11/10/2022