You're listening to Strictly Business Podcast with Lindsay Williams.
I read a piece of work the other day that was entitled The Surging Price of Money.
And it says here, if strategists at a certain American investment bank, which I
won't mention, are correct,
the US bond market is now in the sixth year of the third great bear market since
1790.
Let me say that again, since 1790.
It goes on to say other nations are experiencing a similar exodus from debt.
The yield on 30-year UK gilts recently touched the highest level since 1998.
What is going on?
Jason Bourb-Rasheen, co-portfolio manager, income strategist at 91 in London, is here
to enlighten us.
Jason, it looked so good last year for the bond markets, but suddenly there's a
wobble.
What's going on?
Hey, Lindsay.
Well, I think that's largely been the story for much of the last four years.
And we, as you highlight from that.
that sell side piece have experienced, you know,
one of the most protracted periods of consecutive bond losses and
underperformance relative to cash
over the last 30 years, at least.
And yes, you can take the data back a bit further and make it a longer case too.
And ultimately, I think it's around changing expectations for inflation growth
and policy.
More recently, I think it's been about growth, actually, more so than policy or
indeed inflation.
And those expectations have been...
revised up quite significantly based on what's been going on in the US.
Yes, so we've seen some good jobs data.
We also recently saw a CPI print, consumer price inflation, which was higher than
expected.
And yet there was a surprise sort of reaction from the market.
Can you explain that?
Because it came in at 2.9%, which was above the previous month and above
expectations.
Why did the market take it so beautifully?
Well, the core measure of inflation, which is what the Fed are focused on, came in
below expectations.
Obviously, the level of expectations you're looking at depends somewhat on the
sources from which you draw it.
But if we take Bloomberg as the source for that, then ultimately the core measure,
which is excluding more volatile items that monetary policy shouldn't have an
immediate impact on, things like energy and food,
that core measure was below expectations.
I think you can't necessarily look at it on a month-on-month basis always, because
there are various seasonal factors,
particularly...
after COVID that have made those comparisons more difficult.
I think statisticians are struggling with how to adjust for seasonality,
the fact that some things tend to move up and down based on the time of year.
But ultimately, I think that was a bit of a good news story yesterday, the 15th of
Jan.
But the bigger story for the treasury market, for bond markets generally,
since basically September of last year.
from when you've had around 120 basis point increase in yields,
which when you're running or when a 10-year bond has a sort of seven,
eight-year duration,
is a big capital loss.
It's been about the fact that growth expectations, growth data has come in
above expectations.
You mentioned labour markets there.
I think they're the key force behind that.
We're in a different cycle to those that many would have been used to immediately
after or before the GFC.
And by that, I mean...
Historically, cycles tend to be led by borrowing.
So you have this sort of confidence loop coming from the fact that activity data is
good, you borrow more, you deploy that,
and you go round and round.
And often the labour market is the thing then that cracks eventually.
I think in this cycle, the labour market has been the thing which has led the
cycle.
So it's the fact that initially at least there was this big supply and demand
imbalance in labour markets.
and you've had this quite virtuous cycle instead of wage growth leading to activity
data so consumers spending and that is quite
different i think to uh to previous cycles but that's what makes the labor market so
important yes indeed and also what makes um
the um uh
the bond market uh prick its ears if you like is um the the talk of tariffs in the
united states for
america and it's not just the united states of america because it'll it'll
it'll fan out uh throughout the world Are people making too much of this?
Is it so simple to say that if a 25% tariff is slapped on a particular country
by the
new president of the United States, Donald J.
Trump, that inflation is going to go up because it has to be passed on to the
consumer, the price that is?
Well, it all depends on whether that leads to a trend.
So if you take it in its most simple format, you increase prices on one country
by 10%.
10%.
but their currency then depreciates by 10%.
Your inflation might go up by 10%, but perhaps your consumption of those products
falls by 10%.
So you could end up in a place where you essentially argue that tariffs...
if done in that fashion, and that's the sort of perfect economic model in a sense,
don't really have any lasting impact.
The difficulty is, I think, the reflexivity of tariffs and the lack of
sample size.
So we really only have the 1930s for a protracted, meaningful tariff policy.
And that occurred against the backdrop of the Great Depression.
So it's very hard then to have a great deal of sense of what tariffs mean for
inflation.
And then I think you have the difficulty that, well, how do the...
counter parties to your tariffs actually respond to that.
I take a pretty simple approach, which is I think we need to see a little bit more
of the policy itself and how it's impacting data.
Clearly, markets are going to try to appreciate that in advance.
But nevertheless, I think that's a more cautious or defensive approach to take.
But I actually don't think that much of this move has been in that sort of
September move up in yields about
tariffs.
I think it is a part of it.
people are concerned that the new incoming US administration will be inflationary,
they'll be more fiscally lax,
and that clearly is adding to some concerns in bond markets.
But I do actually think mostly it's about the fact that labour market data has been
stronger.
We went through a phase in the summer of last year where it looked quite weak,
it then appeared to appreciate or accelerate in from September, and I think
bond markets are just reacting to that.
Predictions are predicated on previous data and also present data, of course, and
I notice
One bank that thought there may be as many as three interest rate cuts from the US
Federal Reserve in 2025.
They've gone back a little bit and said, OK, we'll probably get one in June,
given the recent inflation data and labour market data.
It's very, very difficult because it's a month by month change.
As far as I can see, there's a lot of volatility.
How do you distance yourself from this sort of noise that I've just spoken of?
That's the issue is the market is.
as you put it, you know, getting its ears pricked up by one piece of data.
And the issue is that you miss the bigger picture to that.
The approach we take is to try and combine three things.
So the first is fundamentals.
You're trying to look at how that's changing and how it might change in the
future.
So we're trying to look at forward-looking measures of labour market supply and
demand dynamics.
Some of those are higher frequency than others.
but generally what we're looking at is things like sentiment towards the labour
market and that is painting a mixed picture.
Having deteriorated it's now starting to look somewhat more bright so we are aware
that that could be a headwind to
bond markets.
Generalised activity data looks fairly stable and then we complement that by
looking at things such as what we call market price
behaviour.
It ultimately means where is sentiment and where's momentum alongside things like
positioning and these are
quantitative and qualitative aspects.
So that tries to keep us aware of how we might be wrong, tries to keep us a bit
more humble, I think.
Fighting momentum is difficult.
And clearly that has been a one way street for the last four or five months.
But perhaps it's gone a bit extreme now.
And then valuations and for the bond market, they they look fairly compelling.
I think you have to have a sort of shorter term and longer term view on that, because
in the shorter term, yes, yields have risen a lot.
Real yields.
So adjusting them for inflation expectations have further risen, I think.
But you have then in the back of one's mind the fact that things can move a long
way if we are, as you introduced the piece,
in this great bond bear market now having undergone 40 years of bull market moves.
So we're not anchoring to any one thing.
But I do believe when you balance that all out, that the balance of probabilities
favor bonds for a while.
And when I think about the sort of strategies you run, which are quite
defensive, income based strategies.
Yields have risen significantly.
Many investors are sat in cash.
I think when it feels most certain that this has been the sort of lesson over the
last four years,
that the economy and markets are moving in one direction.
And I think increasingly people think, right, the US is in a very strong place.
It's outperforming other areas.
Rates aren't going to come down.
Almost at that point, you need to be willing to go against that intuition.
and start to think well actually could the narrative completely turn on its head and
that's where i think you know starting to deploy into slightly
longer dated bonds i'm not saying you know you buy a 10 year but maybe you start
looking at between three and five year dated bonds in high quality
markets starts to make a lot of sense and that helps you avoid the reinvestment risk
if now actually yields start to come down from
holding cash and it also helps you you know navigate the fear of missing out
ultimately bond markets are going to significantly outperform cash
if now we start to see a reappraisal of growth prospects, particularly given that
bond curves,
so the difference between longer and shorter-dated bonds, are quite steep.
I've led you along a very US-centric narrative during this podcast.
Jason, but I want to go to the United Kingdom because that's where you're
sitting at the moment.
And I said that the yield on the 30-year UK gilts has recently touched the high
since 1990.
It's very much a domestic issue as well as having international influence, obviously.
It's to do with a new Labour government.
It's to do with what I see as a relatively inexperienced Chancellor of the Exchequer.
And it's to do with a controversial budget.
Can they get over that?
So I take a slightly more nuanced view than that.
And the reason for it is if you look at the various differences between UK assets
and international ones,
you don't necessarily arrive at a conclusion that everything that's
occurring in gilt markets is due to the
fiscal lack of orthodoxy displayed in the budget in October.
Instead, I think if you look at the difference between UK bond yields and US
or German,
it hasn't really moved out significantly.
In fact, it's probably flat since the budget.
That's very different to when Liz Truss did spook the markets in 2022.
If you look then at the currency actually against things like the euro and other
non-US currencies,
it's been fairly strong over the last year.
Very recently, it's weakened, but generally it's had a pretty strong
dynamic.
And then if you look just at the change in bond yields in an absolute sense after the
budget,
it doesn't look dramatically out of line.
with previous budgets going back over the last 20 to 30 years.
So I don't think it's helped the UK that the
Chancellor issued what felt to be an expansionary budget and was looking for
more borrowing.
I'm not sure that it's the sole driver.
I actually think the UK is in a difficult position.
It has, you know, big current account deficits.
It's very heavily indebted, and it relies on a lot of foreign lending to it.
And that when you have the sort of reappraisal and bond markets of
expectations as we've seen in the last three to four months that's a very tough
place you know the uk takes that on the nose but
actually the currency has taken it in the shorter run at least more so than the bond
market relative to other bond markets if that
makes sense so i
think they can regain control by issuing some probably more um strength uh you know
strong or
orthodox and fiscal approaches and rowing back on some of those ideas that they put
forward in the budget
But it does require, I think, a settling in broader bond markets for UK gilts to
come down.
You sort of hinted at a couple of instruments that you like.
But let's talk about your overall strategy as we end this podcast.
How are you positioned at the moment?
And is there any likelihood that that positioning could change,
given the data and the volatility of the data that we've described earlier?
Yeah, so we are...
slightly increasing our duration across portfolios from a pretty modest starting
point.
We do see some value, as I've said, start to occur.
We think there's a risk that narrative could change, but this is a very
incremental move from us.
What would then cause us to reverse that would be signs that actually the labour
market is truly accelerating.
Alternatively, it would be that inflation and general growth activity is starting to
pick up once more.
And on the latter two, the more recent data...
has given us some conviction that that's not occurring, but we just need to be
aware of that.
Otherwise, from a hedging perspective, what we've been using is optionality.
And we think that's broadly a good way to diversify portfolios rather than relying
on more traditional asset class
correlations.
Instead, you use options.
And in particular, we've used currency options to try and reduce when bond yields
have been rising,
our capital losses and actually owning the dollar.
over the last few months has worked fairly well in that context.
We still like that idea slightly less than we did before.
And then I think in terms of credit, we prefer non-traditional credit markets,
which look quite tight,
look quite expensive, and don't necessarily offer you much protection from
any rising default risks
or slowing earnings dynamics.
And there we like things such as mortgage-backed securities or
collateralized loan obligations,
where ultimately you've got a probably less economically sensitive asset.
but ultimately one which is offering you a compelling level of yield for its quality.
So put together, I think we are in a pretty uncertain environment.
We're prepared to take a bit more duration risk because the narrative has moved in
one direction for so long.
But I don't think anyone should be maxing out their risk budgets at the moment.
Jason, thank you very much for your analysis.
That was Jason Bourb-Rasheen, co-portfolio manager, Income Strategies at 91 in
London.
The views and opinions expressed in these podcasts are those of Lindsay Williams and
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