Back
I wrote last week that it would probably be my last weekly note of the year as long as the markets stayed calm. Well, I’m afraid I didn’t get my Christmas wish. The US Fed held a meeting on Wednesday and signalled that rate cuts were slowing and the focus was back to fighting inflation. In the UK we saw accelerating wage inflation put the pressure back on the Bank of England. UK bank base rates were expected to head down to the 3%-3.5% range mid-summer. Now that looks to be more like 4%-4.5%. This has predictably put pressure back on the more rate sensitive parts of the equity market, including small and mid-size companies and listed real estate and infrastructure.
What is going on here is that on both sides of the Atlantic central banks are having to fight against governments that are still borrowing large amounts of debt and where fiscal policy is pushing inflation back up. In the US the inflation pressure comes from tariffs and lower immigration. In the UK, from higher taxes on employment and higher minimum and public sector wages. One thing I have been guilty of this year is under-estimating the impact of fiscal policy on bond yields and interest rates. I thought bond yields and interest rates would follow inflation lower. Sadly, this has not been the case for much of the year (and especially has not been true since September).
It also remains interesting to me that two very different approaches (Trump Republican and the UK Labour party) are producing very similar effects in the bond market. Here are UK and US 10 year bond yields for the last 12 months:
This is a different story, of course, to 2022 when UK government policy diverged much more sharply from the US:
This means government policy pushing rates higher is not just a problem for the UK. What are investment implications of this? Three jump out to me:
1. Looking back over 2024, this has been a year of solid economic growth pushing equities higher. The fact that bond prices have fallen (as yields have risen) in this sort of environment is not that surprising and is probably a welcome return to normalcy. Also, our bond overweight has been at the less rate sensitive front end of the market. Our core shorter dated investment grade bond funds are still solidly up for the year.
2. Higher rates are of course bad for borrowers. But part of the reason for these higher rates is stronger wage growth. This means wages are back above inflation again (see below) which should help support consumer demand in 2025 both here and in the US. Good growth normally correlates with positive investment returns.
3. The risk is that higher rates finally bring an end to the equity bull market we have seen for the last couple of years. I still think stronger growth (even stronger wage growth) is something to be welcomed rather than feared but it is still one of the big risks for 2025. We therefore started to diversify a little into less rate sensitive absolute return investments in Q4. I’d expect this to remain an area of focus for 2025.
Finally – and especially if you’ve made this far into an investment focussed note – this weekly will indeed be the last of the year. I’d therefore like to wish you a very merry Christmas and a prosperous and healthy 2025.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
