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The Asset Class: John Stopford · Strictly Business

• 0:00
  You're listening to Strictly Business Podcast with Lindsay Williams.
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  US bond yields are rising, not dramatically, but enough to warrant
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  attention.
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  The US 30-year, for example, has recently broken up through 5%.
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  We know how crucial US rates are to the global financial system and therefore to
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  all asset classes.
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  So this current trend is worthy of discussion.
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  With me to discuss the yield tick up and its potential implications is John
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  Stockford.
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  Head of multi-asset income at 91 in London.
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  Is it as simple as the following?
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  Oil prices going up, therefore the potential for inflation to pick up as
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  well, even more than it is already,
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  and therefore interest rates not to go down, not to go sideways, but to go up
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  themselves.
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  Is it as simple as that, John?
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  I think that's part of the story.
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  So clearly,
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  the war in the Gulf is creating another sort of inflation problem against
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  you know, a backdrop where we've had more inflation than at least targeted for some
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  years with
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  obviously the inflation jump sort of post pandemic.
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  So that's sort of fresh in the memory.
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  We've also got governments borrowing an awful lot of money.
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  So that tends to increase the term premium on longer dated debt.
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  And actually, when you look at the global economy, growth, at least in the short
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  run,
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  and particularly in the United States is doing relatively well.
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  So a combination of okay growth, accelerating inflation,
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  some concerns maybe about how anchored inflation is, lots of government debt.
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  I don't think it's a huge surprise that there's upward pressure on longer dated
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  bond yields.
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  They've risen by less than shorter dated bond yields, which are much more sensitive
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  to near term inflation.
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  But as you point out, they are sort of towards the higher end of the range that
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  we've been in.
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  post-pandemic and back to levels that prior to that we hadn't really seen, you
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  know, for 15, 20 years.
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  Exactly.
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  And you talk about the short term and the long term.
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  Can you describe how this has affected the curve?
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  I mean, the difference in performances between the two-year, the 10-year, the
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  30-year, for example?
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  Yeah.
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  So, typically, when you have a change in expectations of inflation and interest
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  rates,
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  the front end, the shorter dates, dated maturities are much more sensitive.
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  because they're going to be immediately affected by inflation going up for a while
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  or interest rates going up for a
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  while or not coming down, which is what the market was hoping for prior to this
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  war.
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  So they've moved a fair amount.
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  So two-year yields have backed up materially further, 10-year yields.
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  So 10-year yields coming into sort of March were trading below 4%.
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  They're now trading towards 4.5%.
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  30-year yields have probably only moved by about a third, two-thirds maybe of that,
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  a third of that sort of move in tens, and twos and fives have moved by more.
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  So the whole curve, as they say, has flattened, and that's a fairly logical
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  response,
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  but it has pushed yields up across the entire curve just by less at 30 years.
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  A lot of people look at the curve as a predictor for what might happen.
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  They say, well, look when it was this shape 20 years ago.
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  or whatever it was, what is the current curve telling us about the potential
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  crimping of US economic
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  growth and therefore global economic growth, the reaction of the markets to
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  these tick ups in yields?
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  Is there any clue there?
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  Well, I mean, it's obviously raising the cost of long term borrowing.
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  And that's a challenge, both for the US government who, you know, needs to fund
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  their their deficit,
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  but also for companies and businesses borrowing to fund their.
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  their activities.
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  And so that's one aspect.
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  So that's at the margin not very helpful to growth or to corporate profits in the
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  medium term.
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  But also, I think you can look at it as an alternative return opportunity.
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  So if you're an investor, you can invest in lots of different things, including
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  cash,
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  longer data government bonds, equities, and so on.
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  And if you can earn over 5% on a 30-year bond.
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  you sort of need to feel comfortable that equities can give you a better return than
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  that
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  to justify holding them.
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  And the challenge, I guess,
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  at the moment is equity valuations have gone up so far so fast to levels which
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  look expensive relative to history and sort of similar perhaps to previous
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  episodes where
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  equities have appeared to be quite fully priced.
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  So, you know, that sort of dot com.
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  pre-bubble era etc and so you've got this sort of interesting dynamic where
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  The return you can get on longer dated bonds starts to look maybe more
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  interesting or more attractive or more competitive.
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  And equities are already expensive.
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  And so their future returns may start to look less compelling.
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  And so I think the higher yields go,
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  the more that kind of dynamic starts to perhaps put some pressure on the equity
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  market and equity market valuations.
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  As you often do, John, you sounded very sanguine when we first started this
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  podcast.
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  And then there was a definite note of caution.
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  In your last explanation, when I asked whether this is a predictor of what might
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  happen, if there is a note of caution there,
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  are you being more cautious with your positioning at 91?
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  Yes, absolutely.
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  So in the short term, we are fairly cautious about government bonds,
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  because we do have this sort of unusual set of circumstances where inflation is
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  definitely going to pick up
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  and could rise substantially if oil prices keep rising.
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  And so it's interest rates are unlikely to fall and central banks actually are now
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  beginning to think about increasing rates as we saw,
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  for example, the Reserve Bank of Australia did today.
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  So you've got caution maybe about how quickly to lock in those higher yields in
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  bonds.
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  But the flip side of that is potentially this rise in oil prices at some point will
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  actually start to damage the
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  growth outlook, in which case potentially then owning bonds makes sense because at
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  some point
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  even though interest rates might go up in the short term,
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  they may have to come down in the longer term to try and support the economy.
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  And then similarly, on the equity side, equity markets are very gung ho at the
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  moment,
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  driven by huge optimism on earnings, particularly from tech.
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  And a lot of that's linked to a very aggressive capex cycle.
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  But whether that's sustainable, and whether the valuations we're now getting
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  to make sense.
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  I think, is more of an open question.
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  So, we bought equity exposure when we had the initial sell-off in
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  March. And now we're selling that exposure again into strength.
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  So, we think at these kind of levels, we should be overall running less risk,
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  but perhaps being closer to wanting to buy bonds and being happy to sell equities.
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  Final question, and it concerns the US Stoller.
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  The US dollar has been thought to be on the beginnings of a bear market.
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  But suddenly the war came along and people flew to quality and the US dollar was a
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  recipient of that
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  flight.
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  And with bond yields rising, does that support a stronger dollar?
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  I think potentially at the margin,
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  I would say probably the biggest support for the dollar is ironically the US is now
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  a petro currency.
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  So it's in some ways benefiting from the chaos that...
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  Trump has caused in the Middle East,
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  because it has excess oil and other energy-related products that it can
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  export,
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  and those exports are going up.
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  It's benefiting economically in some ways from the war, whereas somewhere like
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  Europe, which is a net energy importer,
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  is being hurt.
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  And so I think it's not surprising that the dollar has done somewhat better during
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  this period.
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  I think, however, in some ways surprising that it hasn't done even better.
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  So actually, the dollar's performance, I would argue, has been rather
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  disappointing.
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  It's moved in the direction you'd expect, but not by much.
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  So when oil prices are rising and risk is under pressure, it's tended to do better.
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  And then the reverse when oil is falling and risk is diminishing.
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  Other currencies arguably have looked more compelling.
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  So we saw gains, for example, in a lot of emerging market currencies before the war.
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  they gave some of that back initially, but then they've regained most of that fairly
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  quickly.
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  So I think it tells you something about capital flows and where people are
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  allocating capital at the moment.
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  And it does seem as though there's less desire to hold quite so many dollars and
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  maybe a bit
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  more desire to diversify exposure, even if the noise hides some of that.
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  John, thank you very much for your time.
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  John Stockford is head of multi-asset income at 91.
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  in London.
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  The views and opinions expressed in these podcasts are those of Lindsay Williams and
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  various contributors and do not reflect the policy,
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  and since we are critically thinking human beings These views are always subject to
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  change,
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  revision and rethinking at any time.
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