Market news and views from the Managed Portfolio Service investment team.
In brief
To yield or not to yield, that is the question. A play on the most famous line of Shakespeare’s Hamlet, but for us a reflection of the market moves of this week and the questions we have to ask as an investment committee over the fixed income allocation. The UK 10-year government bond has moved to levels last seen in 2008, whilst the 30-year has moved to levels last seen in 1998. Whilst mainstream media has compared it to a recent conservative government, it’s also worth noting these moves have occurred to a similar extent in the US. So what is driving them and are they a reason to worry?
Firstly, there isn’t reason to worry just yet. The main factors surround the sustainability of UK and US government borrowing. It is likely that the UK Labour Party will have to change its current fiscal stance, either through lower spending or higher taxes, with the former more likely. The Bank of England (BoE) will be focused on financial stability and may intervene in the bond market in one of two ways, either interest rate cuts or quantitative easing. The most likely starting point for the BoE would be to signal change and observe reaction.
Another factor for the UK is its credit rating. If it is downgraded from here, the next level is quite a significant downgrade and that is something the government will be very aware of as it would push yields higher not lower.
In the US the story is similar, with worries that Trump’s spending is unsustainable but also that the inflation dynamics will be significantly higher based on the strength of the economy. The US yields have reacted to the published Fed minutes from the December meeting that noted worries on immigration, trade and rising prices, alongside a release of stronger economic data on services. The consequences in the short term are likely to weigh on consumers, especially those refinancing debts in the UK or looking to buy in the US. For us, this represents a buying opportunity for government bonds. Yields of around 5% are attractive and if there is any form of intervention or, worst-case, any slowdown in the UK/US economy and rates are cut, there will likely be a rally in these bonds.
That covers the bond moves, but what about the start of the year for equities? Well, its been a positive one for the FTSE 100 Index which is just shy of its four-week high, helped by moves up in the oil price and interest rates. Elsewhere, there has been a mixed start in the US on the back of the Federal Reserve comments, and some volatility in the likes of Japan, where some consolidation is likely ahead of the Bank of Japan's rate decision this month.
In China, the Services PMIs came in better than expected, but yields have dropped back after the Bank of China said it would stop buying its own government bonds due to supply shortages. China continues to try to stimulate its economy but is struggling to make significant headway.
It may seem the start of the year has been mixed, but it’s nothing unexpected. It’s worth reminding ourselves that unemployment is low, consumer spending is resilient and wage inflation supportive. These are factors that support more normal levels of growth and ultimately company earnings. All factors that can move equities higher, albeit with volatility. January is always a rocky month, but there are positives even with the noise.
Next week sees the fourth quarter earnings season kick off in the US with banks reporting. The S&P 500 Index growth rate for the fourth quarter is expected to be 11.9%, the highest since Q4 2021. This also aligns with US CPI and retail sales.
This data will of course follow Friday evening (UK time) release of the employment data. A US-data-heavy week which could either provide momentum to markets for the month or the start of profit taking.
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