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Our views 20 November 2023

JP’s Journal: The hunt for yield is back

5 min read

Last week was about inflation data. As anticipated, UK inflation dropped sharply in October, with UK Consumer Price Index (CPI) falling from 6.7% to 4.6%; this was slightly better than consensus.

Core inflation also moved down from 6.1% to 5.7%. The main reason for lower inflation was energy, not domestic factors, and service inflation will remain a concern for the Bank of England – it was still high at 6.6%. Electricity and gas prices were the main drivers of lower inflation, although food and hospitality also helped. Markets liked the numbers and are now pricing base rates around 4.5% by the end of next year, about 1.5% lower than seen a few months ago.

The US had a similar picture. US CPI was slightly lower than consensus, both for headline and core measures, helped by lower gasoline prices. Headline CPI came in at 3.2% whilst core CPI fell marginally to 4%. Used car prices and air fares declined, after rising the previous month and overall, the weaker inflation picture looked fairly widespread. Markets are clearly saying that rates have peaked, despite the Federal Reserve (Fed) commentary about inflation. Yield curves indicate Fed Funds around 4.3% by the end of 2024; unlike the UK, this implies higher rates than were being priced back in July. Why is this? Basically, because the US economy did much better than other advanced economies in the third quarter.

My view remains, however, that there is a widespread slowdown underway and that this will be more evident in early 2024. The chief reason is that the significant monetary policy tightening seen globally has still to work through. This is already being reflected in higher debt servicing costs and I expect credit growth to come under more pressure. In the UK, growth forecasts are already anaemic but there is scope for a recession. This should herald a quicker downward reaction in rates than implied by markets but there is a caveat. Cornwall Insights, with a good track record on domestic energy pricing, last week raised their forecasts for the UK energy price cap, implying that inflation will be a bit higher as a result. Pushing in the opposite direction, however, is the oil price with Brent trading below $73 / barrel last week, 20% below its 2023 high. Despite the conflict in Gaza, oil has been trending down for two months. Possible explanations include the weakening outlook for US growth, lacklustre Chinese output, higher Russian / Iranian output and reduced speculative activity. This puts a spotlight on the upcoming Organization of the Petroleum Exporting Countries meeting – with a key question of whether output cuts can be sustained or even increased.

Meanwhile, courts threw off the plans of governments last week. The UK Supreme Court ruled that the ‘Rwanda’ migration policy was incompatible with existing laws, while in Germany the Constitutional Court declared that the 2021 Budget was invalid and that the idea to transfer €60bn unused borrowing to the Climate and Transition Fund was illegal. In reality, the effect will be smaller than headlines suggested. It may mean less funding for green projects and therefore a bit less growth, but this will be felt over several years and politicians will find a way to overcome the ruling. The irony is that Germany’s debt situation looks really good compared to other large economies. No wonder Germany is not too eager to share the debt problems of its more profligate neighbours.

US treasury yields fell sharply last week, with the 10-year finishing at 4.4%, a fall of 0.2% on the week. UK 10-year yields matched this move, ending at 4.1% and at the lowest level since May. In the euro area, Italian bonds shrugged off rating concerns with the 10-year moving below 4.4%. Not to be left out, Japanese bonds rallied, settling at 0.75% after flirting with 1% three weeks ago.

Lower government yields, spread tightening and increased confidence helped investment grade bonds perform well last week. Thanks to my colleague Shalin for pointing this out – there was a notable new issue from Barclays: a US dollar AT1 (very low in the capital structure). The issue size was $1.75bn and it attracted demand of around $17bn, which enabled Barclays to issue with a coupon of 9.625%. However, the bond did not show much improvement in secondary markets, suggesting that speculative demand has returned to AT1s – a market that faced an existential crisis eight months ago when Credit Suisse AT1s were wiped out. The issuance also showed how sterling credit remains undervalued compared to other markets, reflecting a shift to more global investment strategies. Investors wanting Barclays AT1 exposure could get a sterling equivalent with a 1% higher yield. This trend of focusing on big, liquid global issues only increases the added value available in sterling and, in particular, its neglected segments.


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.