01 Mar 2023
Jonathan Platt, Head of Fixed Income
There are stirrings on the political front. The resignation of Nicola Sturgeon as leader of the Scottish National Party (SNP) will have repercussions throughout the UK.
A weaker SNP would be good news for the Labour Party as it gives them a double boost: the prospect of more seats in Scotland and a reduced threat of being tarred with the 'Coalition of Chaos' tag used at the last election. Simultaneously, the Prime Minister appears close to a deal on Northern Ireland (NI). This is both a trade and constitutional issue; and it is the latter which is the bigger headache. It looks like the trade issue can be dealt with – via green and red lanes for goods entering NI from Great Britain. What is not so clear is the acceptability of the European Court of Justice to rule on single market issues. Here the Eurosceptic wing of the Conservative Party may have drawn a red line. So, there could be a choice to be made – do a deal with the European Union and accept European Court of Justice jurisdiction or go back to the drawing board and push ahead with the Northern Ireland Protocol Bill which allows for abrogation of parts of the Withdrawal Agreement. There may be a third way; we will have to see. A deal, though, may only be possible with Labour Party support and this could potentially derail Mr Sunak’s premiership if it splits his party. Whichever way I look at it, the electoral prospects of the Labour Party have improved. Not that they need help – currently being well ahead in the latest polls.
The trend against the ‘centre right’ is gaining pace throughout Europe and North America – as highlighted in a recent New Statesman article. Right leaning parties are being pulled in two directions: a socially liberal, relatively free market camp and a more a more socially conservative, bigger state group. The last few but one, UK Prime Ministers held this coalition together but, in general, the contradictions are just too powerful. In Italy, Germany, France, Spain, the US and Canada we are seeing either fragmentation on the right or the triumph of the more socially conservative faction.
What are the longer-term implications for investors? It means the economic case for free markets is losing ground. It also implies that government spending will continue to be an important source of growth. And it probably means that corporate and personal tax rates will edge higher. The countries that will prosper will be those that can harness government spending most effectively to support economic growth. This does not bode for the UK.
On the data front, February’s Purchasing Managers’ Index (PMI) were strong, with sizeable upside surprises in the US and UK. Though the US reading was only 50.2, it was a big improvement. In the euro area the PMI was at a nine-month high; a key change was the revival of growth in financial services activity, supported by resurgent tourism and recreational activities. In the UK, rising customer demand and improving business confidence saw the PMI rise from 48 to 53, again reflecting hopes that global inflationary pressures had started to wane. On the inflation front the picture was mixed. Euro area output price indicators fell but there was less progress elsewhere. Worryingly for the Bank of England, UK businesses are experiencing difficulties filling vacancies despite higher salaries. In the US, Friday’s Personal Consumption Expenditure (PCE) inflation data confirmed a bounce back.
Stylising a bit – government bond markets have transitioned from Hard Landing (mid-December) to Soft Landing (early February) to No Landing (end February). Looking at the short end of the US treasury curve we can see that yields have risen by about 50bps in two months. However, it is the transition from Soft Landing to No Landing that has seen the bulk of the move. The Federal Funds rates are priced at around 5.25% for year end, compared with 4.6% at the beginning of the month. This change in rate expectation has been global and has been reflected in bond markets. 10-year Treasuries ended the week approaching 4%, the highest level since early November, whilst in the UK 30-year yields moved to the highest level since mid-October. In Germany, 2-year yields exceeded 3% for the first time since 2008.
Credit markets were a big beneficiary of the move from Hard to Soft Landing and, although progress has stalled in recent weeks, sentiment remains reasonable. This was illustrated last week by the euro issue from Banca Monte dei Paschi. Claiming to be the world’s oldest bank, it has had a chequered recent history. But it was able to issue a senior short dated bond at a yield not far above where Credit Suisse equivalents are trading – how things change. At a broader level, non-gilt sterling indices widened 3bps on the week whilst high yield spreads were about broadly unchanged. My preference still remains for investment grade over high yield.
My take is that the No Landing scenario implies higher rates. I still believe that the tightening of monetary policy we have already seen will bring down inflation and slow growth. If this does not happen in a timely way there is a danger that central banks go into overkill. In that case buying a bit more duration in government bonds may not be a bad thing, as recessions will follow.
This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.