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Our views 28 March 2022

JP’s Journal: The power of the dog

5 min read

I see that Kermode and Mayo, Radio 5 Live's film buffs, are leaving the BBC. I can put myself forward as their new reviewer based upon my recent experiences.

Basically, ‘Belfast’ was good, but not great. ‘The Power of the Dog’ was bad; this contrasts with the critics, who generally liked it a lot. Social media seems to agree with me.

This highlights a dilemma seen in markets. Expert opinion dominates idea formation. Conversely, the ‘wisdom of crowds’, the collective views of the general public, often offer better insights into what is going on. Inflation is a good case in point. The informed expert consensus, until recently, has been that inflation would remain low and that deflation was at least as great a threat – just think of all the talk in 2020 and early 2021 about the possibility of UK rates going negative. The public have generally been more sceptical, signalling greater concern about inflation.

We like to think that experts, such as economists and central banks, have better insights. And they generally do. However, the process of forming a consensus tends to be based upon thought leadership by a narrow group meaning that biases can become engrained. Less informed opinions, lacking some insights but wider ranging and not anchored by implicit biases, sometimes offer better judgments.

So where are we now? The consensus is that inflation will be high this year. Whilst the Bank of England (BoE) expects a sharp fall in following years, the public are more cautious. Those that followed my Journal last year will know that I have warned about a pick-up in inflation but that I don’t believe in stagflation or the entrenchment of inflation. In this I am going against the ‘wisdom of crowds’ and am more aligned with BoE thinking. This worries me I must confess.

Turning to the UK’s Spring Statement. It was more of the same: some muddled thinking and no clear strategy. Dangling a 1p tax cut in the run-up to an election shows how devoid of ideas and short term our leaders are. This may be harsh given the government has faced three major challenges: disentanglement from the EU, Covid and Ukraine. Yes, aligning national insurance thresholds with income tax is good and reducing VAT on some renewables coupled with a temporary reduction in fuel duties makes sense. But protecting the housing assets of the wealthy, as determined last year, is neither prudent nor fair. This is particularly so when living standards of the less well-off are coming under such pressure. With overall taxation at high levels it is difficult to see the productivity miracle that would help mitigate the long-term downward trend in growth. 

Delving into the details a bit more, the UK’s budget deficit was revised up for 2022-23, reflecting higher debt interest costs (painful when nearly a third of debt is linked to the Retail Price Index) and the fiscal impact of the measures announced. The Office for Budget Responsibility (OBR) think that about a third of the overall fall in living standards that households would otherwise have faced has now been offset, but that the measures only reverse a quarter of the aggregate revenue gain from the personal tax rises that were announced during 2021. What this means is that through fiscal drag, higher corporate tax rates and more student loan repayments (changes confirmed last week), we will see a smaller deficit in future years. Hence the scope for the 2024 tax inducement.

Interestingly there appears to be a clear difference between OBR and BoE thinking on growth with the latter more pessimistic, seeing GDP growth of 1.3% for next year, compared with 1.8% from the OBR. I am siding with the BoE, again.

Government bonds

All this may sound a bit parochial given the significant global sell-off in bonds last week. Higher inflation readings, US Federal Reserve hawkishness and the reality of less central bank support for markets combined to see yields move higher across the board. Yields on 10-year treasuries approached 2.5%, the German equivalent nearly 0.6% whilst the 10-year gilt ended at 1.7%.

If you thought that long index linked were the best place to be in this environment you are in for a shock. So far this year the longest dated UK index linked gilt has lost over 20%. So why have long-dated index linked bonds not been a safe haven in a time of rising inflation and risk aversion? Well, at the risk of sounding like a broken record, it’s down to real yields.

At longer maturities, inflation expectations have risen by 10-15 bps (that’s good if you are seeking inflation protection) but real yields have shot up by nearly 50 bps. (that’s bad if you bought when real yields were nearer -2.5%). When you have duration of 30 years or more that translates into some hefty losses.

Conversely, the five-year index linked gilt has posted a marginal gain on the year, despite the move higher in interest rate expectations. The Debt Management Office must be wishing for a reversal in the real yields given a remit which sees nearly 15% of the £125bn debt funding via index linked issuance.


Last week credit markets were well behaved with poor absolute returns reflecting movements in underlying government bond yields. However, it has not been a great period for investment grade sterling credit, with Q1 likely to be the worst quarter since the financial crisis. This is due to gilt yield moves coupled with spread widening of 25 bps. The observation that sterling credit has outperformed gilts, at the ‘all maturity’ index level, reflects the longer duration of the latter.

I am still inclined to keep bond duration short of benchmark and to be overweight credit, through diversified strategies. But growth – or its absence – may well be an imminent problem, so don’t get too bearish on bonds.


Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.