22 Sep 2020
18 September 2020 | Jupiter Independent Funds Team
With the prevalence of Covid-19 and its rapid and significant disruption to the global economy, not surprisingly the tectonic plates on which central banks sit are gradually shifting as countries deploy their own different strategies to deal with the fall-out. This week, the Bank of England and the US Federal Reserve (Fed) held their respective September meetings, and both warmed to themes aired publicly at the recent Jackson Hole policy symposium and before that.
We have discussed before how the Fed threw a spanner in the works at Jackson Hole in August, breaking ranks with its major western peers: it severed the one common golden thread running through their various mandates of a nominal 2% inflation target. There is nothing wrong with this new approach: in many ways it is more pragmatic than slavishly trying to hit 2% on the nail every time. But if the Fed is now aspiring to achieve 2% as an average over a period of years while everyone else is still trying to hit the bull’s eye every month or quarter, then inevitably policies are more likely to diverge raising tensions where, on that particular score at least, few existed previously.
Fed Chairman, Jerome Powell, had already steered markets towards the current interest rate policy of 0%-0.25% persisting until at least the end of 2022. This week, in addition to maintaining his commitment to using the central bank’s balance sheet to make credit available through quantitative easing, he indicated interest rates could remain static for even longer: his intention is to leave rates alone until full employment (i.e. below 4%, when it is 8.4% currently) has been restored and inflation is on track to exceed 2% for some time so that the 2% average can be achieved. His language of “tolerating higher inflation” and his previous assertion that he loses no sleep over the burgeoning levels of US debt imply he believes the US economy should be allowed to run hot through a combination of ultra-loose Fed monetary and central government fiscal policies. Whether such excess inflation materialises or not when surplus capacity in capital and labour has been soaked up remains to be seen: recent history points to it having been a struggle to maintain 2% inflation despite the relatively benign economic conditions for most of the last decade in the US.
The sea-change in thinking towards negative interest rates continues at the Bank of England. Under Mark Carney’s governorship, negative interest rates were a taboo. Governor Bailey believes them to be an essential element of the Bank’s toolkit. The Bank has not explicitly said it will deploy negative base interest rates, but its recent language and this week’s Monetary Policy Meeting minutes clearly point to a growing appetite to use them if the need arises. It is detectable that as the number of UK Covid-19 cases is accelerating again, and with it the gradual re-imposition of the curtailment of freedoms, the Bank’s tone on the subject has become more urgent.
There are arguments for and against the use of negative interest rates, though in our view we think them a fundamentally bad idea. But if the Bank insists on using them the trick is to avoid the obvious and potentially fatal trap of turning the conventional banking model on its head. For all its complexities, banking is a very simple principle: it attracts capital from depositors by rewarding them with a rate of interest and recycles that cash in to loans, charging the borrowers a higher rate of interest; the bank makes money on the differential rate; existing loans being repaid augment new deposits and so the cycle proceeds. Negative rates invert this and break the cycle: borrowers are paid to take out loans while depositors are charged to store their money; the implications of a liquidity crunch for the bank are obvious, something only too vividly seen in the eurozone where a half-decade’s worth of such policies have severely undermined the European banking model and the European Central Bank has had to come up with ever more creative structures to prop up the entire system. Sweden was the first western economy to employ negative interest rates; it is instructive that towards the end of last year it started to attempt to raise rates back at least to zero: the insidious and pernicious effect of long-term negative rates had proved too economically debilitating. Take note, Mr Bailey.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. The recent conditions have indeed been challenging; pleasingly, the Jupiter Merlin Portfolios have held up well.
Please note: Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
Fund specific risks: The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.
Important Information: This document is intended for investment professionals and is not for the use or benefit of other persons, including retail investors. This document is for informational purposes only and is not investment advice. Past performance is no guide to the future. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Holding examples are not a recommendation to buy or sell. Quoted yields are not guaranteed and may change in the future. Issued by Jupiter Unit Trust Managers Limited (JUTM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ which is authorised and regulated by the Financial Conduct Authority. No part of this document may be reproduced in any manner without the prior permission of JUTM. 26206