25 April 2017
“The UK was the best-performing developed government bond market in 2016, with the decision to leave the European Union (EU) and subsequent central bank stimulus driving gilt yields to historic lows. However, with interest rates already near zero and ongoing currency weakness, we believe that the Bank of England is less likely to press ahead with further monetary easing.”
“The UK economy has also proven more resilient in the wake of the EU referendum than many anticipated. Brexit negotiations are yet to begin and comments by Prime Minister May suggest that the country may be heading towards a hard, rather than a soft exit. A government proposal to borrow more for investments in technology and infrastructure (fiscal stimulus) has the potential to drive yields higher via an increase in supply, or indirectly via rating agency downgrades. Foreign ownership of gilts has fallen 25% since the peak in 2008, which makes Bank of England Governor Carney’s concern regarding the “kindness of strangers” to fund the UK’s large current account deficit easy to understand. The UK might find it harder to cover future shortfalls due to referendum concerns.”
Against his short UK position, Tim explains where he sees value in the rest of the developed world.
“Relative value strategies are an important component of our interest rate approach, with Sweden a favoured long position against our short in the UK. The Swedish yield curve remains steep on a relative basis and while rising inflation has seen yields rise at the front end of the curve, the prospect of policy normalisation has the potential to drive down longer-dated yields. Indeed, this is exactly what happened during the first quarter of 2017.”
Source: Bloomberg, 18 April 2017
“Unlike the UK and US, where household debt fell following the financial crisis of 2008, Sweden has seen no such adjustment with household debt as a percentage of GDP approaching 170%, versus 140% in the UK and 110% in the US. This suggests that Swedish households are far more exposed to rising interest rates that those in the UK or US.”
Outside of the interest rates universe, Tim has a brighter view on the foreign exchange market, he comments: “Currencies are and will prove to be a most useful tool to reflect tactical changes and news events. This is particularly true in the current environment of economic and political divergence. The recent rise in the pound has received a lot of attention and may be seen as a headwind to UK corporates, but it is important to remember that the British currency remains some 14% weaker against the greenback since the UK referendum and in our opinion continues to support the corporate sector at these levels.”
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