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Our views 03 April 2023

JP’s Journal: Viva España!

5 min read

Some thoughts on Spain, having come back from a trip to Seville, Granada and Cordoba. First, a fantastic spring climate with glorious smells of orange blossom lingering through many streets.

Second, some wonderful sightseeing – the Alhambra, Cordoba Mosque and Seville Cathedral. Third, a lovely open culture – not to mention great wine at a third of the UK price.

At a more down to earth level, we used public transport to get around. Fast, clean, and on-time trains linked the cities, making journeys really easy. Seville is similar in size to Leeds but the transport comparison is stark. Never mind the failure to link Leeds to the HS2 network, the real scandal is the ineptitude of governments in not investing in a joined up northern transport hub. Getting a higher speed, reliable link between Liverpool, Manchester, Leeds and Newcastle should be a priority. With 50% of the UK population living north of Milton Keynes, the majority definitely deserve better.

Markets recovered some poise after the US financial wobble and the implosion of Credit Suisse. A lot has been said about the Swiss National Bank’s treatment of AT1 bondholders (junior in the debt capital structure). It is a good reminder that Switzerland is not the EU and will enforce its own laws and regulations as it sees fit. The bottom line is that the global cost of bank debt has gone up and will not come down so easily. It means that banks will need to rethink their models – using more equity and less debt. In practice, it may mean lower dividends and fewer share buybacks, offset by less subordinated debt issuance.

So where does this leave bank debt? An elevated differential between senior and junior bank debt will be maintained, although I do think there is value in current valuations of AT1. The national champions look like the natural winners but always bear in mind it is easier to rescue a small bank than a large one. Depositors are the big winners though. In some respects it is understandable that authorities have protected them, as bank runs can quickly become a general stampede. But it seems bad practice, with no incentive for depositors to seek out ‘safe’ banks, just those that pay the highest rates. This is not how a market system should work.

On the economic front, revised fourth quarter UK data showed that output was a bit more resilient than I expected. The most surprising aspect was the upward revision to real consumer spending, despite a rise in the savings ratio. A big part must be due to the £5.7bn received by households under the Energy Bills Support Scheme. An improvement in the current account deficit was also helpful, although business investment was downgraded sharply.

Over the weekend a Saudi initiative to reduce oil output resulted in a jump in the oil price to $84 a barrel, reversing the recent trend which had seen the price dip to $73 in mid-March. This is not what western government and central banks want to see. Indeed, last week saw a move higher in implied inflation in most markets. Looking at the US treasury market we can see that 20-year breakevens have risen by 0.2% in the last few weeks. The same pattern can be seen in other markets: in the UK, implied inflation at the 20-year horizon is now above 3.5%.

What do these moves mean? Possibly not a lot – as there is always a danger of over interpreting short-term changes. However, with a peak in interest rates coming closer there remains a worry among bond investors that central banks will tolerate higher inflation than their mandates imply. As a result, real yields are doing better than nominal rates. Yields on 10-year US treasuries rose back above 3.5% and German equivalent yields hit 2.3%. Actually, given the turmoil in the banking sector I have been surprised at the relatively poor performance of government bonds – I thought there would have been a stronger bid for perceived ‘safe’ assets.

In credit markets the fallout from the Credit Suisse collapse is still the main focus. At the index level there was a rally in both investment grade and high yield, reflecting some recovery in financial bonds and a renewed appetite for risk assets. However, sentiment remain fragile and our preference for well covenanted bonds and sector diversification remains in place; such an approach, I think, is well suited to present conditions.

My view remains that the relief rally we have seen in riskier assets will not be maintained. The headwinds that the global economy faces, particularly a squeeze of corporate margins, is being underestimated. Government support for households has proved to be an important source of assistance but will not continue at the same pace. So, my preference remains investment grade credit and longer government bonds if duration is required.


This is a financial promotion and is not investment advice. 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.