News Archive

Universal sentiment in markets is very often wrong. Whilst many investors are underweight in gilts, we believe there is a plausible case for owning this asset class in 2010.

Yesterday’s announcement of 0.1% positive quarter-on-quarter growth, after six quarters of contraction, speaks to the fragile nature of the UK economic recovery. We believe the key to positive gilt demand in 2010 will be weak economic performance.

When quantitative easing began in March of last year the consensus view was that it would cause a bull run in the gilt market – this did not happen. The positioning of the Fund with this in mind was a primary factor in generating the positive performance of the City Financial Strategic Gilt Fund in 2009, the only such positive return amongst its peers last year[1].

Rather than a surge in gilts, 2009 was characterised by a long and sustained rally in the equities markets. While this may have been simply coincidental to quantitative easing, it suggests that we should consider the possibility that a withdrawal of quantitative easing will have an equal, but opposite, effect. We could therefore see a retracement in equities and a much more stable gilt market than is currently built into most forecasts.

Regardless of who crosses the threshold of number 11 next, serious fiscal tightening is all but certain. The withdrawal of government spending on this scale will imperil the economic recovery that today’s announcement suggests is rather fragile. As a policymaker, how do you tighten fiscal policy and terminate quantitative easing without falling into a double-dip recession?

The FSA is also expected to increase the amount of highly rated liquid assets that deposit-taking banks must keep on their balance sheets – this could fund a significant proportion of this year’s government borrowing requirement.

Whilst quantitative easing has bolstered the narrow measure of the money supply, this massive injection of liquidity has had no effect at all on the wider measures of money supply. The real economy will not feel the benefits until the banks begin to on lend the money currently on deposit with the Bank of England. This is why we would not rule out a further easing in monetary policy either through a cut in interest rates, possibly to Swedish-style negative interest rates, or through further quantitative easing. These measures could help to offset fiscal tightening.

Investors will need to weigh these factors to achieve the proper balance between equities and fixed interest within their portfolios.

– Ian Williams

[1] Source: Lipper, 31.12.2008 – 31.12.2009. Note: IMA UK Git Sector.