February Market Update – the end of really cheap money

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For financial professionals only

What's moving markets

Investors usually talk stocks – it’s the volatility that catches their attention – but it’s bonds that provide real insight to the underlying health of economies. The ongoing debate around negative rates may have ended this month, as the Bank of England raised rates again. Back-to-back UK rate rises has not been seen since 2004 and after an extended period of emergency rate policy, this feels like a radical moment.

The shift from 0.25% to 0.5% attempts to stifle run-away inflation, and was widely predicted by markets and commentators. Possibly more newsworthy is the fact 4 Monetary Policy Committee members wanted to move twice as fast, plus the unanimous decision to begin reducing the stock of bond purchases. Combined with the rate rises, this showcases the determination to move from a period of quantitative easing into a new phase of quantitative tightening. Only time will tell whether these actions deliver the required result.

It remains to be seen if higher interest rates can curb the inflation that’s currently ripping through the system – a direct result of supply chain disruptions and higher energy prices. Mid-month, the bond markets sent an important message following the recent UK hikes saying the risk of a recession has increased, and delivery via the yield curve flattening and momentarily inverting.

An inverted yield curve means shorter term borrowings become more expensive than longer term and this can suggest a looming recessionary environment. That’s not to say just because the yield curve inverts a recession will follow, but it’s widely known to be a reasonable indicator. Inflation has been widely debated, even if there’s been no agreement whether it’s transitory or not. During the month, the January annual inflation rate was reported at 5.5%, a slight increase from the previous month of 5.4%, but the pace of growth has slowed materially which could point to the economy nearing the peak of inflation.

The situation in Ukraine has shocked the world, as Russia moved to a full-scale invasion. World leaders were quick to condemn the actions of Russia and looked to address the situation with a barrage of sanctions. Unsurprisingly, markets reacted to the news of this appalling attack and risk assets sold off aggressively towards the end of the month. Energy is likely to be hugely impacted, and the knock-on effect could be inflation remaining elevated for longer.

Asset class implications

Market expectations of rising rates continued over the month. This provided yields with a further upward trajectory, putting further pressure on gilt prices. The UK 2-year gilt yield started and ended the month at a similar level but peaked at 1.54%, with the 10-year up from roughly 1.31% to 1.43% and peaking at around 1.59%. Yields peaked towards the middle of the month, but as news broke of the Russian invasion, fell back given the severity of the situation. However, this may have been limited due to inflationary pressures.

Our tactical solutions remain underweight to Gilts, focused on giving additional protection against rising yields to lower risk portfolios, and we keep a watchful eye on attractive entry points.

Elsewhere, equity markets fell with the impact of higher inflation concerning investors. Higher interest rates bring an increase to the so-called ‘discount rate’, impacting the pricing of future cash flows by reducing their value, and making equities less attractively priced. Linking this to equity styles, a higher interest rate could prove positive for sectors currently characterised as ‘value’, such as financial stocks. The value rotation witnessed in January continued into February and has become one of the strongest on record. The US equity market is materially exposed to the technology sector, a major ‘growth’ sector, which explains the recent performance challenges.

By far, the full-scale invasion of Ukraine by Russia provided the greatest impact on monthly returns from the capital markets. Markets moved into a risk-off mode owing to a great deal of uncertainty and negative sentiment from concerned investors, which will have large global ramifications. We are deeply saddened and shocked by the war, and can only hope for a quick diplomatic resolution where the invasion is halted immediately.

Asset classes in numbers

FTSE Actuaries UK Conventional Gilts All Stocks TR in GB-1.37-7.68-10.06-3.023.93
ICE BofA Global Broad Market Hedge GBP TR in GB-1.29-5.13-6.84-1.784.58
IA UK Direct Property TR in GB0.863.2510.3310.206.11
FTSE All Share TR in GB-0.473.8417.3816.0318.37
FTSE USA TR in GB-3.05-6.1017.8118.6161.58
FTSE World Europe ex UK GTR in GB-3.99-5.566.858.9332.80
FTSE Japan TR in GB-0.86-5.05-2.65-0.8821.30
FTSE Asia Pacific ex Japan TR in GB-0.98-4.02-4.27-6.7324.24
FTSE Emerging TR in GB-2.93-3.08-1.73-3.7421.52

Source: FE Analytics, GBP total return (%) to last month end

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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