Written by:
Alex Chappell
Investment Manager at Amber River DB Wood
So, what’s on investors’ minds? Well, the core challenge remains the push and pull dynamic between economic growth and inflation. These variables also differ by geography, with the US, UK and Europe all have slightly different landscapes at present.
After a strong start to the quarter in July, our portfolio range treaded water in August. Global stock markets have enjoyed a good recovery since the tariff chaos in April, advancing by around 5% year to date, albeit enduring a very choppy ride along the way. In August specifically, all asset classes struggled to digest the forward path for inflation, interest rates and fiscal policy, and so after the highs of July, August felt like a pause for thought.
So, what’s on investors’ minds? Well, the core challenge remains the push and pull dynamic between economic growth and inflation. These variables also differ by geography, with the US, UK and Europe all having slightly different landscapes at present. Inflation is above target in all areas, though closer to target in Europe and the US, with the UK getting the award for the stickiest inflation rate. This in turn places different strains and pressures on the various Governments and Central Banks.
On the inflation front, August caused more concern with readings coming in slightly above forecast. In the UK, we now have CPI at 3.8% to the end of July. So far the Bank of England seem to be looking through that, once again cutting interest rates by 0.25% last month, to leave the base rate at 4%. Like us, they continue to believe the currently elevated inflation rate is temporary, and are therefore happy to look further ahead. At the same time though, additional rate reductions are unlikely until inflation drops back into the 2’s. We expect we may be left with this status quo for a few months yet.
Similarly, it seems we have started to see the impact of tariffs in the US inflation numbers. Positively though, the US have an annual inflation rate of 2.7%, providing the Federal Reserve more room to cut interest rates next month, as we expect.
Bond yields are largely determined by the expected level of interest rates, and they in turn influence how much government pays to service its debt. In the absence of the right level of economic growth, a government is left with very little choice other than to increase taxes to fund higher debt service costs. The US and UK are currently grappling with this challenge, though respective governments are taking contrasting approaches in dealing with the problem. Over the pond, tariffs are the tax measure being used to raise revenue, whereas here, it is tax policy directly. Neither is great for the consumer, which is the biggest engine of growth in any developed economy. If the consumer is under pressure, they will spend less, companies will make less profit, and governments collect less tax, so in turn, debt rises. To add to this vicious circle, if their strategy to grow the economy is seen as ineffective, markets will lose confidence, and the cost of borrowing will rise further, potentially leading to debt levels spiralling. All a little concerning, though let’s hold that thought as we will discuss it more in our pre-budget blog in October.
In summary, although we have painted a realistic picture of the challenges ahead, it isn’t all bad news. It is worth remembering that even though government debt levels are high, business and household debt levels are currently the lowest they have been in decades.
In summary, although we have painted a realistic picture of the challenges ahead, it isn’t all bad news. It is worth remembering that even though government debt levels are high, business and household debt levels are currently the lowest they have been in decades.
In summary, although we have painted a realistic picture of the challenges ahead, it isn’t all bad news. It is worth remembering that even though government debt levels are high, business and household debt levels are currently the lowest they have been in decades. This is a key reason why despite 10% inflation and a rapid rise in interest rates in 2022 and 2023, we haven’t had a recession. Households and businesses in general have been able to ride it out for now. However, we do need some positive signs of productivity increases, falling inflation and a lower cost of borrowing if we are to navigate better times ahead.
Of course, there is a positive impact of higher bond yields for investors. It was widely shared in the press that the UK 30-year Gilt (government bond) hit its highest level since 1998 this week, now yielding c5.7% per annum. It is a slight oversimplification, but that essentially means it is now possible to lock in 5.7% per annum for 30 years. Similarly, as we have covered lots of times, the income yields on our portfolios remain high, with the lower risk portfolios offering between 5% and 6% per annum, and even the higher risk ones c3% per annum. We actively trade this allocation, to add more exposure when yields are higher (such as right now) and reduce when they are lower. All in all though, unless interest rates get dramatically cut, those income returns will continue to underpin the portfolios for some time to come, which is good news. To highlight the demand for fixed income, the UK 10-year Gilt auction was considerably over subscribed this week, with investors keen to lock in income returns of 4.7% for 10 years. Not a bad foundation to build portfolio returns.
Looking forward we have a fascinating last four months of the year to come. Here in the UK the budget will naturally be the focus though there is lots in addition to consider. Despite the challenges, we head into the last stage of the year with positive returns of between 5.00% (Very Low Risk) and 7.36% (High Risk) across the portfolio range, to the end of August.
Please note: our next blog will be a Question the Committee edition for 2025, where we invite you to pose a question to our investment team, who will aim to answer them in a Q&A style blog on Friday 19th September. Our last edition was very well received, so we would be delighted if you want to contribute this year.
To submit a question, please just email us at questions@amberriverdbwood.com by Monday 15th September.
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