June Commentary

While fixed interest markets have remained broadly static this Spring, equities have generally advanced a little, particularly in the USA.  Factors behind these trends include the continuing gradual reduction in the quantitative easing programme in the USA and an increasing realisation that at some point US interest rates will begin to rise, as will those in the UK.  What is also clear is that, in the Eurozone, measures taken to stimulate growth put the prospect of interest rate rises well into the future.

Both the timing and the likely scale of interest rate changes over time are of great relevance to Fixed Interest markets because when the interest rate trend looks set to rise, the value of fixed interest investments is adjusted downwards so that, broadly, yields continue to reflect the markets expectation of future rates.

In the UK, I think it reasonable to suggest that markets are now adjusting for a modest increase in the Base Rate at some point over the next year or so but precise timing is almost impossible to forecast.  Thereafter, the Bank of England is suggesting that rates may gradually rise to around 3% over the next few years, well short of the previous norm of, broadly, around 5%.

The implication for Fixed Interest markets of a gradual rise in the base rate to 3% is negative and on this basis I continue to advise that investors remain underweight in this sector except for those seeking to achieve a relatively high income at the expense of capital preservation. Furthermore, Fixed Interest investors in tax sheltered arrangements (typically ISAs and pension funds) benefit from the receipt of gross interest which clearly provides a boost for them.

Equity investors are more reliant on a much wider range of factors and on the basis that a return to more normal interest rates over time suggests that economies are on the mend, opportunities within the equity sector remain, particularly if inflation is kept in hand.  Thus overweighting equity funds continues to be my preferred tactic.