Bonds took centre stage last week, and it wasn’t just the premiere of ‘No Time to Die’ at the Royal Albert Hall. The interest rates on global government bonds rose on the back of increased concerns that central banks would raise borrowing costs earlier, in the face of sustained inflationary pressures from the global supply chain issues. This caused jitters in the equity markets, with the MSCI All-Country World Index down -1.4% in GBP terms (-2.2% in local currency terms).
US 10 year treasury yields rose from 1.31% the previous week and peaked at 1.54%. The sell- off in the UK gilt market was even more pronounced, with yields on the 10 year benchmark rising above 1% for the first time since the onset of the pandemic. What has been even more stark in recent weeks is the very sharp rise in UK “breakeven” inflation rates. These are interpreted as market participant’s expectation of what inflation will run at, on average, over a particular period. For instance, the 5 year breakeven market was at one stage forecasting inflation of 4% over the same period. The market is currently heavily impacted by the inflation hedging activities of pension funds, which diminishes its predictive ability, but it is a measure of just how much anxiety about the global fuel shortage is troubling markets.
While panic-buying has made the energy shortage particularly acute in the UK, the effects are very much reverberating globally. Power plants using natural gas were very efficient as stop-gaps for renewable energy sources when there was no wind or sun. A decade of underinvestment in traditional energy sources, in favour of renewables, has made the system more fragile and liable to supply shocks. This has caused the global liquefied natural gas price to round trip from a record low to a record high in less than a year. While we think these bottlenecks will get resolved, they may keep inflation higher for longer than central banks had expected. We would also anticipate this to be relatively accretive to the positions in our portfolios that benefit from higher inflation and interest rates. In the face of the media headlines, challenges, and opportunities posed, it is important that investors keep the same poise and composure of 007, shaken not stirred.