It is often said that market participants dislike uncertainty, but I think that the opposite is true. Investors thrive on weighing up options for outcomes and then backing their views. Making choices in a world of imperfect knowledge is what we all do.
The Government are no different and the Chancellor’s approach, as set out in the Budget, illustrates the difficult choices now faced. He decided to keep fiscal policy supportive in the near term with significant new fiscal tightening measures delayed until the second of half of the government’s term. That looks sensible but there are hard choices embedded in this approach. Can the government tighten policy as envisaged in the medium term? The economics of a 1% pay offer to the NHS may be sound but the politics look wobbly. I doubt whether the actual settlement will be below 2.5%. The decision to raise the corporation tax rate in two years’ time to 25% may be a good politics but flies in the face of previous government rhetoric that low tax rates lead to higher tax takes. Freezing personal allowances is painless now but, in the run, up to a general election will that still be the case? – I doubt it.
I think the Covid crisis has revealed a real dilemma at the heart of this government: the struggle between those that see Brexit as an opportunity for the State to become more involved in society policy and those that want the role of the State significantly reduced. This has yet to be resolved.
Nevertheless, the Budget was a reasonable attempt to tell markets that the government was serious about addressing the level of public debt. It may be that the economists who wrote to the Times last week arguing that interest rates were so low that further fiscal expansion was desirable have a case – based upon the Modern Monetary Theory. But this seems risky for a mid-sized open economy like the UK and possibly generationally unfair. Even on present projections I see the case for further Bank of England support for the gilt market if we are to avoid a rise in long-term interest rates.
One measure that caught attention was the business investment ‘super-deduction’, where over the next two years, when companies invest, they can reduce their tax bill by 130% of the cost of that investment. The OBR expects this to act as a strong incentive to bring forward investment plans and in 2022-23 they estimate that the measure will raise the level of business investment by around 10%. I think this is an imaginative approach.
Cash, government bonds and currencies
UK Cash rates moved higher in the week whilst US rates were unchanged. Sterling moved down against a stronger US dollar but up against the euro.
In the US, non-farm payrolls rose 379K, much stronger than consensus expectations (198K) in February with the greatest gains being in hospitality and leisure – helped by the loosening in social distancing restrictions on businesses in several states. On Saturday the Senate passed the American Rescue Plan Bill, a $1.9 trillion fiscal injection, providing big increases in spending on healthcare, education, unemployment support, vaccine initiatives and child poverty eradication policies.
Ten-year US government bond yields ended above 1.5% as fears of fiscal loosening, incipient inflation and debt supply weighed on markets. Conversely, in the UK ten-year gilt yields declined to 0.75% with the curve flattening as investors were attracted to thirty-year yields approaching 1.4%. In the eurozone, government yields were broadly unchanged. Implied inflation moved higher in the US but was unchanged in the UK and eurozone.
Our government funds are now broadly neutral duration.
Sterling investment grade credit indices moved sidewards over the week with credit spreads a touch wider and underlying gilt yields a bit lower.
We got involved in a new unsecured bond from Workspace – a company that lets office, industrial and workshop spaces to small and medium sized companies. Although we prefer secured debt the 1.75% yield spread over gilt yields was attractive for a seven-year bond.
Overall relative performance in our sterling credit strategies remains good – although absolute returns have been hit by the rise in gilt yields. Our strongest contributors so far this year have been ABS and the financial sectors.
Another relatively quiet week – with global investment grade indices weakening on higher US yields. High yield indices also fell with spreads widening a few basis points.
Our funds bought into a new issue by Tronox, a specialty chemicals company and added to our exposure to the US consumer via a new issue from Cinemark. Overall, performance across our high yield and multi asset strategies remains robust reflecting both market trends and security selection.
Back to the theme of hard choices. Last week Lord Hill’s Listing Review advocated major changes to listing rules. Again, there is a clear dilemma here: trying to make the UK more attractive to global capital but preserving the UK’s status as a well-regulated financial centre. In recent months RLAM’s credit teams have been beefing up our review of what constitutes good governance – especially relevant to our sterling and global sustainable credit strategies – and it would be a pity if, in the interests of short-term gain, we allow the UK’s reputation to suffer. Time will tell.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.
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