Our hand was forced to sell Eurozone bond holdings by the sudden sharp rise in sterling following the Bank of England’s surprise 0.25% rate increase. If the pound continues to be belligerently strong and for the time being it might well be, then euro-denominated bond investments will have to stay off limits.
Bond markets 2007: UK inflation expectations
The Bank of England raised interest rates by 0.25% to 5.25% – just about everybody had expected the Bank to remain pat. It was assumed that the Bank had seen the forthcoming inflation figures and that they would be worse than expected, at least 3% which is exactly where the CPI was, the Retail Price Inflation figure was much higher at 4.4% and that is the index used in most wage bargaining. The immediate expectation was that further rate hikes are to follow, perhaps even as soon as February, that was until Mervyn King, in a speech this week, hinted that the rate rise cycle had ended. Are you confused?
As we have been saying all along, the bond markets are not pricing-in a serious inflationary risk, given the Bank Governor’s recent speech when he said that the Bank expected inflation to fall, possibly quite sharply, in the second half of 2007. Bond markets seem to have it right.
At the same time as the Bank of England were deciding to raise rates, the European Central Bank left them unchanged at 3.25% but Claude Trichet left the door open and a 0.25% rise is expected, maybe as soon as February.
Bond markets 2007: no clues from the Fed
US market rates, as measured by 3-month money, provide no clues whatsoever, bumping along at 5.25%, the same as the Fed’s funds rate. Looking at the weekly chart, it can be seen that historically the reactions above and below the thirty week moving average have been key. The recent action has been subdued below the thirty week moving average which, with nothing else to rely upon, would be an indication that US rates are set to go lower. That would not be entirely unexpected because Goldman Sachs’ US Strategist, David Kostin, reckons the Fed will need to slash interest rates three times this year as the housing market slump goes from bad to worse, which also fits in with Bill Gross of PIMCO, the world’s largest bond fund manager whose view is for a rate of 4% by year end. That would certainly be in the wake of deteriorating asset prices.
Of one thing we have no doubt, 2007 is going to be a very interesting year and will probably turn out differently to what most people expect.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/