As eyes are on the US Fed minutes release later today, spare a thought for the Bank of England quietly celebrating (if you can call it that) a decade of dovishness. It may not feel like it has been that long but today marks a decade since the last interest rate rise for the UK. The 12 months prior to this (between 2006 and 2007) saw 5 hikes to a peak of 5.75% on the 5th July 2007. It wasn’t long before the subprime mortgage crisis contaminated global markets with the Bank of England cutting rates 3 times to settle at 5% for a while, only to see an international banking crisis ensue, plunging rates across the world. After 6 lurching cuts the UK’s base rate finally settled at a mere 0.5%. Then for around 7 years markets have been anticipating these ultra-low rates to be phased out; but in August last year the BoE cut the rate again in half to 0.25% following the vote on Brexit. There it has remained for the past year, with interest rates 23x less than a decade ago.
As the era of low rates continues to be prolonged beyond past expectations - with economies still struggling to spur growth - some investors are cautious about what reaction the first rate rise in a decade could bring. But if the US Fed case study is anything to go by, markets are rightly becoming increasingly focused on the longer term trajectory of rates rather than getting agitated over what could either be considered a potential doubling of the base rate or be viewed as a nominal 25bps rise. With the last MPC vote being 3-5 for a rise and inflation now running at 2.9%, this could be enough to invert the vote distribution. BoE Chief Economist Andy Haldane has become increasingly hawkish and publically so, and last week BoE Governor Mark Carney stated, ‘some removal of monetary stimulus is likely to become necessary’. Carney alone joining Forbes, McCafferty and Saunders would be enough to carry a hike decision.
The ongoing concern of course is the modest economic data; GDP growth for the first quarter was just 0.2% and average earning growth is just half what it was a decade ago. Adding to this are the uncertainties of Brexit and many other declining signals such as today’s slowing service sector growth and car sales figures. With a slowing economy the MPC will likely be near glacial in their trajectory as they look for how consumer spending reacts to the straits of rising rates, rising inflation and weaker wage growth.
Accounting for all these realities we still see attractive value in parts of the bond market. Not in the ‘high yield’ space where the name is not really accurate anymore but where the high risks remain in the face of even slight rises in interest rates and tightening of credit conditions. Not in the ‘low yield’ and ‘negative yield’ space where the absence of a spread cushion makes them more proportionately vulnerable to even a minor hike. Contrastingly a portfolio of diversified high grade credit which has a cushion in the spread from creditor nations that do not have to outgrow their vast debts still yields around 4%, with the potential for further gains from our relative value investment process that targets undervalued securities.