While many UK investors have been drawn to the turmoil in UK and UK government bonds, they should not ignore the global context in which these rips have taken place.
Led by the US Federal Reserve, there has been a concerted drive for higher interest rates in developed countries as central banks react to the spikes in inflation.
They are trying to correct the mistakes of 2021 when they persisted too long with ultra-low rates and lots of extra money creation. From New York to New Zealand and from Brussels to Seoul, official interest rates have risen. This has led to bond sell-offs, pushing longer-term interest rates up in sympathy with official short-term rates. I kept the fund out of the longer bonds in anticipation of these moves.
Only China and Japan have been excluded from these changes. They kept inflation low by limiting the expansion of their money supply, keeping credit and prices under better control. Japan still borrows money at about zero interest.
The danger now is that central banks will switch from making the mistake of making too much money and credit at too low rates (which is inflationary) to too little money and credit at too high rates, causing a recession. When asked, the Fed replies that hard drugs are needed to curb inflation, their only priority at the moment.
This year, the 10-year U.S. government debt rose from 1.65 percent to a peak of 3.94 percent on September 27. This has pushed US mortgage rates up more than 6 percent and led to a sharp decline in the housing market. market.
The European Central Bank is too late to stop buying bonds and raise interest rates, but German 10-year government bond costs are still rising from a negative figure at the start of the year to a peak of 2.2 percent recently. With German inflation above 10 percent, that still seems low and means more rate hikes will follow.
Both the Fed and the European Central Bank have made clear that they want to raise interest rates further, fueling the frenetic sell-off in September. As a result, the interest on very long bonds is now often lower than the interest on shorter bonds. This reflects the growing market view that we are heading for a sharp slowdown in activity that could lead to recession in some countries.
Once a recession has been long enough and deep enough to convince the central bank that inflation has died down, they will have to cut official interest rates again.
As we approach the northern winter, markets should be concerned about the ongoing supply problems in the energy markets. The EU has just announced policies to reduce demand for electricity during peak periods, limit prices and tax excess profits.
If the winter is cold – with too many windless days – the EU may need to step up its efforts to ration power, causing more problems for industry in general and energy consuming companies in particular. The US is in a stronger position with a surplus of gas for its own needs. The surveys point to a slowdown or recession with weaker industrial orders.
This background was also not helpful for most stock markets. The clear intention of central banks to reduce demand, money and credit in the system means lower revenue growth, declining profit margins and lower profits for many companies. The market is also not yet in a position to provide a clear and credible timeline on how long central banks will continue to pursue strict policies and when they will have to admit that a slowdown will not turn into a slump.
The portfolio has held on to stocks as a balanced fund should, focusing on a broadly diversified portfolio across the global index. Breaking out of the Nasdaq, the US technology index, kept losses under control, with the world index having some sectors, such as energy, that have outperformed in these difficult circumstances.
The fund still retains some of its specialized exchange-traded funds that provide exposure to the digital revolution and the green transition. As the activity of the underlying companies in these areas continued to grow, their overall performance suffered from the markets discounting future earnings and profit growth at higher discount rates to reflect rising interest rates. Clean energy and battery technology perform best when countries try to push the pace of investment in renewable energy.
We’ve had such a sell-off in bonds that I’m starting some of the fund’s cash in 10-year Treasury bonds. The global investment markets will not perform well until the US changes its policy of promoting recession. European markets rightly remain nervous about the war in Ukraine and the disrupted energy markets.
As I write this, the market is recovering in hopes of some limits to rising interest rates as there is mounting evidence that inflation will fall next year. Bonds should be the first to change.
If we’re lucky, the Fed will begin to relax before triggering a deep recession. If not, the Fed will ease more at a later date. Either way, inflation will be a lot lower and longer-term interest rates will fall.
Sir John Redwood is global chief strategist for Charles Stanley. The FT Fund is a dummy portfolio designed to demonstrate how investors can use a wide variety of ETFs to gain exposure to global equity markets while keeping investment costs low. email@example.com