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Fixed Interest Feb 2010
Why we do not like Fixed Interest - February 2010
2009 was a good year for UK fixed interest investment. The strong returns were driven by a combination of high yields and strong demand which in turn was driven by the Bank of England's Quantitative Easing (QE).
This QE policy has seen £200 billion injected into the monetary system, the largest amount compared to the size of the economy of any of the leading global economies. This strategy is due to end in February 2010 and nearly all commentators are saying that the QE policy will not be extended further.
All of this is well known and therefore can reasonably assumed to be reflected in the current market price. We have seen yields fall back from high single figures to mid range ones. There is an argument that compared to base rates yields are still too high and that there remains scope for further capital appreciation.
The unknown is what impact QE will have on inflation (even the Monetary Policy Committee (MPC) admits they do not know this). In addition it is difficult to predict how investor sentiment will be affected by the formal announcement that QE has ceased.
At some point (possibly towards end of 2010, although it could be later) the MPC will need to reverse the process of QE and start to recover the money it has injected into the market. This action will also have unknown impacts on market sentiment.
Many of these same issues also apply to investment in overseas fixed interest securities.
Given that we have seen strong growth in the fixed interest sector, albeit from very low starting values, it seems reasonable to view that upside potential has now been significantly reduced. Equally it can be argued that the risk of investing in fixed interest compared to the potential return has increased to a level where investors are no longer being adequately rewarded for the economic investment risk they are taking.
This QE policy has seen £200 billion injected into the monetary system, the largest amount compared to the size of the economy of any of the leading global economies. This strategy is due to end in February 2010 and nearly all commentators are saying that the QE policy will not be extended further.
All of this is well known and therefore can reasonably assumed to be reflected in the current market price. We have seen yields fall back from high single figures to mid range ones. There is an argument that compared to base rates yields are still too high and that there remains scope for further capital appreciation.
The unknown is what impact QE will have on inflation (even the Monetary Policy Committee (MPC) admits they do not know this). In addition it is difficult to predict how investor sentiment will be affected by the formal announcement that QE has ceased.
At some point (possibly towards end of 2010, although it could be later) the MPC will need to reverse the process of QE and start to recover the money it has injected into the market. This action will also have unknown impacts on market sentiment.
Many of these same issues also apply to investment in overseas fixed interest securities.
Given that we have seen strong growth in the fixed interest sector, albeit from very low starting values, it seems reasonable to view that upside potential has now been significantly reduced. Equally it can be argued that the risk of investing in fixed interest compared to the potential return has increased to a level where investors are no longer being adequately rewarded for the economic investment risk they are taking.
