Some quarters it can be hard to think of a subject to write about but not this time. The government’s mini budget was political suicide but worse, it immediately negatively impacted millions of mortgage holders on flexible rates and added 1% to the market rate of interest. That will have an immediate negative impact on the economy. Immediately it takes money out of people’s pockets who have variable rate mortgages, while millions more are starting to plan for a higher rate when their current fixed rates run out. It is the most ridiculous political display and economic madness.

This government will pay dearly and quite rightly. Interest rates were going to rise anyway, and they are in every major country. However, it did not need to happen in a disorderly manner.

There have been second order effects as well in the financial markets. Stocks fell, particularly UK focused ones. Interest rate sensitive stocks such as funds focused on infrastructure and commercial property were particularly hit.

One ray of light is that the UK 2-year Government Treasury bond now gives a risk-free return of 4%. It has not been possible to get any return on bonds for many years. There are also many very good quality corporate bonds now offering yields of 6%. For example, Tesco have a bond with a 6% coupon redeemable in 2029. This currently trades at £97 having been issued at £100 some years ago. This means by paying £97, you receive annual interest of 6.18% (6/97) and in 2029 you are repaid at 100, a slight capital uplift from the price of £97. It is difficult to underestimate this change.

This Tesco bond was trading at £135 at the beginning of 2021. At that time the yield being 6/135 or 4.4%. Tesco takes £1 in every £8 spent in the UK so they have no cash flow issues and will not have any problems repaying this bond. What this means is we can finally buy low risk and low volatile bonds into client’s portfolio’s and if you have cash looking for a home that you previously did not want invested into stocks, there are now finally options. Another example is a Nestle bond which was issued with a coupon of only 0.625% but now trades at a level where you receive 5% per annum. Again, Nestle is a wonderful company with better cash flow than many countries and 5% seems quite attractive.

Government policy

What does the government need to do? There is an argument to say that the Conservatives should lance the boil immediately and put in an interim leader/team that can return credibility and take them to the next election. This would limit the damage to UK plc. At the very least fiscal credibility needs to be restored and the government needs to lay out a credible policy as soon as possible. In the meantime, there will be drift.

Tax cuts are fine IF you square the other side of the equation i.e., spending. You can not have tax cuts and more spending; it is one or the other. If they are going for tax cuts there must be spending cuts somewhere to match. If that is not possible then the mini-budget must be reversed. All this needs to happen quickly. The original talk of it all going on until another statement on 23rd November was far too long. The government is now saying they will issue a statement at the end of October, but this also is far too long.

Quantitative easing

What this saga has shown us is that as financial market interest rates reached around 4% there were considerable strains across many parts of the markets and economy. Some of this was because it was not expected and happened so quickly however it may be the first signs of where the top of the cycle in rates will be. There were predictions of rates hitting 6% + but this level is simply

not sustainable for business, or consumers, and part of the dislocation was the markets realising this. My guess is that they will peak much lower than some are suggesting.

Bank of England and Pensions regulator

It is not only the government who are massively disappointing. The Bank of England and the Pensions regulators deserve special mention and need to up their game significantly.

The Bank is being too short sighted in its outlook and in how it communicates. We seem to go along from meeting to meeting with little idea as to the next move. Where there is some idea, it is only for the next meeting and nothing beyond that. What the bank should be doing is communicating where rates are going over the next year. For example, it should say now we are going to move interest rates up to 4% by April 2023 then hold them with a view to further rises. That way if inflation levels out, they may change their language in the New Year to, our bias is now to keep rates level for six month pending further data. These longer outlooks give consumers, business, and banks time to plan. Currently we are not given any reasonable outlook.

Defined benefit pensions

The Bank has been utterly asleep with Defined Benefit Pensions. It now seems they have allowed Defined Benefit Pensions to take enormous risk buying geared derivatives. Such instruments are meant to hedge interest rate risk. They have no place in a pension.

A Defined Benefit Pension is a simple concept, a workforce will have an age profile. Those workers save during their working life. The pension needs to match its future liabilities with its investments. In theory, bonds are great for this because they have fixed redemption rates so a pension fund should hold for example a combination of 2-year bonds, 10-year bonds and 30-year bonds. The mix will be determined by factors such as the age profile of the current and past workers. It is worrying that it has been possible for these funds which hold real people’s money, to be buying geared derivatives. The practice should be banned. There is no place for gearing within any pension. It is particularly frustrating for us because we see such bureaucracy from the regulators when it comes to running a SIPP or for a client to withdraw even small sums from their SIPP, yet at the same time, they allow practices such as these!

Paul Coffin
October 2022


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