A rollercoaster week across asset markets saw the yield on benchmark 10-year US Treasury jump 8bps to 1.80%. Meanwhile, sterling extended losses against the US dollar, falling to its weakest level since the GFC. Despite recent economic data such as retail sales surprising on the upside sterling is being pounded by worries over a 'hard Brexit'. The pound closed the week 16% weaker against the dollar year-to-date and has plummeted more than 18% against the euro. In fact the currency is one of the worst performing against the greenback so far this year; worst than the Argentinian Peso, and sitting ahead of the Angolan kwanza, Nigerian naira and the Venezuelan bolivar! Former BoE governor Mervyn King last week claimed that the weaker pound is a 'welcome change' adding that the Brexit concerns are ‘over the top’. He went on to comment that during the referendum campaign, it was noted that Brexit would push inflation higher, and that house prices and sterling would fall; basically what the BoE has ‘been trying to achieve for the past three years and now … have a chance of getting it.’
The Gilt market has also taken a beating as concerns over fiscal spending and the weaker sterling increased. The combination of a weak currency, higher inflation and increased government spending (at record low borrowing levels) may put even further pressure on the Gilt market. The market’s expectations for a surge in inflation has pushed the 5-year, 5-year GBP inflation swap rate up ~24% to 2013 levels during the week; from the lows at the end of July.
As all our funds are US dollar denominated we have very little exposure to sterling currency moves. Across our portfolios we hold a couple of sterling bonds; the likes of state-owned Russian Railways 7.487% 2031 which has rallied over 28%, and Scottish Widows 5.5% 2023 has gained 6% on a total return basis year-to-date. Both bonds continue to offer attractive risk-adjusted returns of 18.2% and 12.7% with yields of 5.8% and 4.2%, respectively. Although denominated in sterling, these bonds are fully hedged so our exposure to sterling is zero.
Elsewhere, the Fed minutes show a committee mixed with a 7:3 vote not to raise rates in September, but it does appear that the voting members are moving closer to a 25bps rise when they meet in December, a move in November is unlikely due to the election; but a Trump withdrawal could open the door here as well; data dependent of course.
Helicopter money, the transfer of cash directly to consumers from central banks, in order to immediately stimulate economies has been looked at time and time again, particularly recently in Japan. The concept has been around for many years since it was first dreamed up by Nobel Laureate Milton Friedman nearly fifty years ago. ECB President Draghi described it as a 'very interesting concept' while Mark Carney called it a 'flight of fancy' and Japan's governor Kuroda has said it is prohibited by current Japanese law.