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29/09/2021
Liontrust Insights: Time to dust off the old textbooks for when interest rates go up

By David Roberts, Manager within the Liontrust Global Fixed Income Process

There were few market commentaries that accurately predicted how the US Federal Reserve and Bank of England would react to the current growth and inflation debacle. Hardly any that I read spotted the resultant hawkish tone, nor the bearish bond market reaction.

The question is why the change of tone now? We’ve had a QE (quantitative easing) decade and 18 months of pandemic misery during which we have been constantly dismayed by the underestimation of the disruptive impact of massive monetary and fiscal stimuli. Central banks failed to spot inflation – which has averaged 4% in the US since March while 4%+ is likely to be seen in the UK and Germany later this year.

Central banks failed to spot the economic imbalances that unfettered free money inevitably brings: Evergrande and the UK natural gas debacle are just the latest examples. They failed to understand the impact of price rises on rampant nominal growth. And let’s be honest, the “it’s all about jobs” argument just doesn’t wash with over 10 million vacancies in the US and a record 1.2 million in the UK, and yet unemployment remains around 5% in each country.

Comments from the Federal Open Market Committee (FOMC) and BoE’s Monetary Policy Committee (MPC) suggest a quicker reduction in free money than many had thought. The Fed was up first. An initial reading of its statement suggested to many a modestly more hawkish tone but one that could be ignored by investors. However, events later that week proved catalysts for bond market sell-offs and renewed talk of “reflation”.

Two members of the MPC wanted to end QE. The accompanying rhetoric talked of high inflation and a risk of it going higher still. Around the same time, the Norges Bank raised interest rates – yes, that can happen!

Taken together, these actions seemed to cause a reappraisal of the Fed’s position. Bond markets had one of their worst days for years. UK 10 year gilt yields threatened to move to 1% (still 3% below the MPC short-term inflation forecast). We haven’t seen this level for around two and a half years.

Arguably central banks should have been reducing stimulus for the past year ahead of the inflation spike. Perhaps the level of economic imbalance is now just too great to ignore? For example, the MPC noted the economic threat from higher UK gas prices. In the past, they would have ignored this and not responded to “idiosyncratic” events. The problem is that when adding all the idiosyncratic events together, it starts to look systemic.

Market rates have risen but in truth just a little and only to levels that should still favour borrowers. However, signs are that several other central banks will follow the Norwegians and raise rates in the coming months. Maybe it’s time to dust off those old investment textbooks and read how to invest when interest rates go up?




Liontrust Key risks and Disclaimers

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated investment business.


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