More pertinent to investors (but linked to both Covid and the US election) is what has been happening among the leading western central banks as they try to make sense of the political and economic future. US 10 Year government bond yields having already diverged from their counterparts in Europe and the UK since August (Federal Reserve Chairman Powell’s shifting of the inflation target from a nominal 2% to 2% being an average to which to aspire over time) were 0.9% before Christmas; on Tuesday this week they reached 1.17% (in context the equivalent German 10Y government bonds trade at minus 0.54%). This widening in the spread between the two, and indeed the nominal increase in US yields (the corollary of rising yields being falling bond prices) indicates fixed income investors perceive a rising risk that US interest rates will go up sooner than the Fed has indicated will be the case. Is there any foundation for their nervousness? Yes, is the answer.
Since the Democrats unexpectedly and belatedly took both Senate seats in Georgia to leave them tied with the Republicans, convention says that the Democrat leader in the Senate (Kamala Harris, Biden’s vice-president elect) has the casting vote. The Democrats now have a clean sweep to pursue their policies, the fiscal element of which includes extensive federal expenditure on Covid relief, infrastructure, the green economy and levelling inequality. If the Fed was looking for fiscal symmetry to its own monetary support through quantitative easing (QE) and ultra-low interest rates, its wish is likely to be granted. However, notwithstanding Chairman Powell’s insistence that policy remains unchanged, several of his colleagues, notably in Dallas, Richmond, Chicago and Atlanta have gone public suggesting that the landscape has changed and that 2021 presents the opportunity to rein in QE and reduce the Federal balance sheet; further, they sniff the risk of the potentially inflationary effect of the fiscal stimulus programme, allowing the inference that interest rates might begin rising before 2023, the date until which Powell has hitherto maintained they would remain static. Similar to January 2019 and Powell’s ‘policy pivot’, it raises questions about who is running US monetary policy: the Fed or the markets? But in terms of investment risk, history suggests that every time the Fed tries to tighten policy, particularly the QE element, markets take fright (known as the ‘taper tantrums’).
Meanwhile in the UK, although interest rate policy and QE remain unchanged, yet more kites have been hoisted aloft floating the idea of negative interest rates being employed in 2021. It has happened so often now that Bank Governor Bailey runs the risk of repeating the mistakes of his predecessor, Mark Carney, crying wolf but doing nothing. Make no mistake, employing negative interest rates is not a decision to be taken lightly, and as we have written about on many occasions we believe they are fundamentally a Bad Thing; but sometimes you do wish Bailey and his colleagues would either put up (more accurately ‘down’!) or shut up.
In Europe, a much under-reported comment from a senior economist at the European Central Bank hinted at the political pressure being applied by France in particular (given the parlous state of its chronic indebtedness) for the mother of all debt forgiveness programmes. If negative interest rates are radical, debt forgiveness in the EU, the world’s largest trading bloc not much smaller than the GDP of China, and encompassing the euro, the world’s second most-traded currency after the US dollar and a global reserve currency, would be nuclear. It would call in to question the whole concept of the obligations inherent in borrowing, and it would raise serious doubts about the trust in the value of fiat money. Is this another kite-flying exercise, or is there the germ of real intent? Would it be acceptable to the fiscal conservatives (Holland, Finland, Austria, Denmark, Germany etc)? Has this got legs? Time will tell but the fact it is being discussed at all is fascinating.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
Past performance is no guide to the future. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the authors at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.