All of this suggests higher interest rates. We have seen this already in emerging markets where countries have increased rates to limit the damage done by currency devaluation, but in the USA there is a big difference between cutting back on quantitative easing (known as tapering) and actually increasing rates. In the UK, the strength of Sterling suggests that markets take the view that this country is likely to be the first developed economy where interest rates will need to rise but the latest inflation figures, showing a further reduction in the CPI, have pushed this threat further back and Sterling has lost some of its recent gains as a consequence. In the Eurozone, monetary policy may yet have to loosen further if deflation were to emerge as a significant threat.
In the meanwhile, in the Far East the Government’s aim is to increase inflation in Japan, which indicates a continued loosening of monetary policy, while China is sending out mixed signals as concerns over too much borrowing through the secondary banking system remain.
On UK matters, latest guidance from the Bank of England on interest rate policy has reduced the focus on unemployment, which has fallen sharply. Instead, the focus is on what might be termed slack in the economy, i.e. the ability of “UK PLC” to produce more without taking on extra cost. Monitoring this is, of course, extremely difficult: suffice to say that the latest downturn in inflation as measured by the CPI certainly takes immediate pressure off interest rates. However, it has not been widely reported that the RPI (relevant to pensioners and index linked gilts) has continued to rise so that the gap between the two has widened.
We are now in the middle of the 2013 company reporting season. So far, while some in the financial sector have disappointed, others have been more encouraging. Dividends continue to increase but at a slower rate than last year, much as anticipated in our recent Newsletter.
My conclusion from all of this is that the medium term outlook for fixed interest investment remains neutral and it continues to be a sector that I underweight in portfolios. Equity valuations in developed markets remain reasonable while risks remain in emerging countries.