Church House, Chief Investment Officer James Mahon provides a measured commentary on what has been a challenging third quarter of the year.
An appalling quarter on so many fronts ended at just about the worst point possible for investors. It had started reasonably well with an improvement in equity and bond markets through July and early August. Putin’s ‘gas attack’ on Europe in mid-August put paid to this, and energy prices leapt again, adding to concerns here as UK inflation for July breached the 10% mark. Meanwhile, the Conservative Party leadership contest dragged on interminably (with little sign of active government at the time). Then came that extraordinary week in early September when Liz Truss travelled to Balmoral for her first royal audience, immediately following Boris Johnson’s resignation, and culminated in the sad news of the death of the Queen.
Gilts don’t often hit the headlines, but that all changed in the week following Kwasi Kwarteng’s ‘Fiscal Statement’ on 23rd September. This was a shockingly inept ‘amateur hour’ display from the new Government, made even worse by the prior sacking of Tom Scholar as Permanent Secretary to the Treasury. How on earth did they expect markets to react, particularly the Gilt market (where the Government borrows to fund its over-spending), when they announce ‘spend, spend, spend’ with no indication of how this was to be paid for. Rather summed-up by this week’s Economist headline: HOW NOT TO RUN A COUNTRY.
The price of Gilts duly collapsed (meaning that interest yields rose rapidly) and, despite some disappointing misinformation on the topic from the BBC, it was true to say that the Gilt Market had fallen into disarray and was not functioning properly. This was the moment when the Bank of England, correctly, stepped in to provide a backstop and some order was restored. The result is that available rates of interest for longer periods have reversed the falls of the past twelve years since the financial crisis of 2008/9. The shock was that it happened so quickly, leaving holders of longer-dated Gilts (and other fixed interest securities) nursing heavy capital losses.
Inflation is still the key to all this. Led by the US Federal Reserve, central banks, including the Bank of England, have been raising their base interest rates in an attempt to tackle it, and we expect to see more increases. Here, and in Europe, consumers and businesses are to be shielded from the prospect of massive jumps in fuel prices (though these are abating somewhat), which will provide significant relief. But central bank (and inept political) actions mean that a mild recession in the US looks likely now, while the European economy is already in recession as is, probably, ours.
The better side of the coin is that, for the first time in years, one can see decent returns on offer in the Gilt market and other fixed interest securities. My suspicion is that these markets, along with equity markets, have now ‘priced-in’ a lot of bad news (it has been relentless!). I hope that I am right in this, doubtless we will have to endure more volatility and ‘market stress’ on the way…
The full Quarterly Review is available here.
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