Half of wealth managers expect UK borrowing costs to be higher by early 2018, as the tone of the Bank of England has turned increasingly hawkish and a widening gulf opened between rate setters.
A majority believed the global economy is resilient enough to weather higher borrowing costs, with the 70% who expect corporate profits to continue rising the highest since mid-2014. But the depth of anxiety among a bearish minority has intensified sharply as central banks have edged to the exit.
The surprise fall in June inflation figures to 2.6% from 2.9% in the prior month was widely perceived to have earned the BoE some breathing space. Virtually none of the readers who took part in our quarterly survey believed that this would be a sustained reprieve following 2016’s sterling crash, however.
Governor Mark Carney had earlier pledged to ‘look through’ imported inflation. But the five-three split on the Monetary Policy Committee last month – the biggest dissenting vote since 2011 with three members recommending a 0.25% rise – suggested that is not a unanimous view on the panel.
‘I believe the Bank of England was wrong to cut rates last year and employ additional QE [following Brexit],’ said Richard Scott, senior fund manager at Hawksmoor. ‘They risk going into the next recession with an enfeebled monetary arsenal as it seems the governor feels under little compulsion to ever raise rates!’
Stefano Del Federico, co-founder of The Private Investment Office, echoed that sentiment. ‘[Rates will rise] in the next six months, otherwise they will not have the ability to stimulate the economy after the stock market correction.’
Readers have been aggressively underweight sovereign risk for the near six-year history of the poll. But the number of readers who cited an ‘unwinding’ of excess liquidity and a bond market rerating as the biggest risk factor for investors has recently risen to an overwhelming majority.
‘The Bank of England is miles behind the inflation curve and has failed in its main objective to promote price stability,’ said Tavistock chief investment officer Christopher Peel. ‘Returns across the gilt curve will be negative (nominal and adjusted for inflation).’
An increasingly anxious minority of readers were quite vocal in their fears that any rate rise would be needed to squash a speculative bubble in limited risk assets. This would jeopardise the health of the wider economy, rather than moderate a sustained uptick in underlying activity.
‘Which alternatives to hold,’ will be the critical call, suggested head of private clients at Thomas Miller Andrew Herberts. ‘[And] how to value them. A lot of private client investors appear to have been chasing alternative investments such as infrastructure (witness the enthusiasm over recent fund raises).
‘There is a point at which their diversifying properties become diluted as prices appear to be getting ahead of fundamentals – at which point they may act as any other risk asset.
He added: ‘The key risk to markets is an exogenous shock which shakes investors out of their current complacency. The fundamental backdrop in terms of both the economy and earnings is positive, but equity valuations already discount much of this. Thus there is little downside cushion for shocks.’
Corporate risk highs
Despite the widely-cited fears of a policy mis-step, the level of risk appetite in corporate debt stood at a year high, with the 17.6% of readers overweight, the highest since Q3 2016.
Views on the asset class were as polarised as they have ever been in the six-year history of the survey however, with 64.7% underweight and just 17% at benchmark weighting.
This reach for carry/yield was even more evident in emerging market debt. The 17.6% overweight both hard and local currency classes is the highest since Q3 2013.
EM equity appetite was the most aggressive in the history of the survey, but the absence of effusive narrative commentary on this idea suggested this may be due to a lack of opportunity elsewhere.
While allocations to Japanese and European equity markets remained high, UK and US overweight allocations stood at their lowest in the poll’s history.
‘Europe remains a crowded trade, but for a good reason – reasonable valuations and an improving economy,’ said Brewin Dolphin divisional director Rob Burgeman. ‘Brexit blues and political deadlock are likely to continue to weigh on the UK.’