Fixed Income

Carney announces a “comprehensive, coherent and timely package”

08-Aug-2016

 

A cut in interest rates, a boost to the QE scheme and a new “term funding scheme” - what will that mean for investors today?

 


I can’t help but think Mr. Carney has been listening to recordings of his own, relatively dire, predictions of a post-Brexit UK economy, and is now setting monetary policy to match. If the measure of massive, untested monetary stimulus was taken at 5pm on the day it was announced, I think we could count this as an unmitigated success! Initial market reactions to Thursday’s announcement by the Bank of England are significant and as expected – Sterling is down 1.50%, FTSE is up 1.70%, ten year UK Government Bonds are up 1.20% and sterling corporate bonds are rallying hard.*

So what was announced?

Mr. Carney announced a “comprehensive, coherent and timely package” predicated largely on the projected loss of 2.5% of economic output over the next 3 years, with 2017 growth sub-1% and unemployment closer to 5.5% than the current 5%**. While the market had fully expected and discounted the, unanimously agreed, 25bp cut it ultimately received, the rest of the package and the promise that all elements could be expanded in the future sent the bond markets soaring.

An expansion of the long dormant government QE program to £435Bn (+£60Bn) and the addition of corporate bond buying up to £10Bn has provided further support to a market that, until now, didn’t seem in need of help. Bonds have already turned in a handsome return for investors this year, up nearly 10%, and outperforming equity markets* – this package will likely only drive this further.

Bonds have already turned in a handsome return for investors this year, up nearly 10%, and outperforming equity markets – this package will likely only drive this further.

Interestingly, there is a growing recognition that the policies designed to re-invigorate the economy (rate cuts and QE) are destructive for bank earnings and capital generation. Like the Bank of Japan and ECB, before it, the Bank of England has thrown a bone to the banking system by way of a new Term Funding Scheme – effectively an attempt to offset the pressure on bank margins with extremely cheap funding from the central bank – if your mortgage rate doesn’t head immediately south, your bank’s regulator (the BOE) will likely be unimpressed!

We believe the effect on the Blackrock Corporate Bond Fund and newly launched Blackrock Sterling Strategic Bond Fund will be positive. We have long held the view that both interest rate risk and credit risk are necessary and desirable to generate attractive returns and provide income – both of these things are working. Our thesis that ultimately the UK’s withdrawal from the European Union would be worse for Europe than for the UK is bolstered further by aggressively supportive monetary policy and a weaker currency. Our preference for quality UK based assets, including banks, is being rewarded as the central bank attempts to bring down borrowing costs across the board. We expect strong returns as we move into the quieter summer period.

Many of my conversations with clients over the last six months have centred on the extent and limits of global monetary policy. “Have they run out of bullets? Is it working?” On Thursday, we learnt that the Bank of England has a lot of ammo left but the second question is harder to answer – and will have to wait for another, longer, blog.

Ben Edwards
Director, lead fund manager of BlackRock Corporate Bond Fund and co-manager of the BlackRock Sterling Strategic Bond Fund

*Source: Bloomberg, 4th August 2016
** Source: Bank of England, August Inflation Report

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 05/08/2016 and may change as subsequent conditions vary.