21 July 2023
As we venture into the summer of 2023, the Bank of England’s (BoE) latest move – a 0.5% hike in interest rates to 5% – reminded us of the iconic song ‘Let’s Twist Again’ by Chubby Checker. ‘Do you remember when things were really hummin’?’ Well, we do. Just go back to MVAM’s newsletter from June 2021 (‘The Blip is Back’) where we suggested that things were hummin’ in a way that inflation was far from ‘transitory’ as the BoE governor Andrew Haldane then suggested. By last summer it was clear even to our own ‘Chubby Chequer’ that things were a little out of hand when it came to inflation. But still, rates in the UK started to rise at 0.25% a time. That was out of step with the US. The Federal Reserve were increasing rates at 0.5% each meeting.
So last year, when the economy was ripe for a rate hike, the bank hesitated. Now it’s twisting again by raising rates faster than anticipated at a time where it seems clear things are slowing. The Federal Reserve has stopped its rate rises. The UK saw two consecutive months in a row (April and May) where mortgage debt actually fell. People are paying down their mortgages. This is the first time it has happened since records for this began in 1992. House prices are falling too. Latest estimates have house prices down around 2% versus 12 months ago. A fall of 2% isn’t much but if you factor in the 9% inflation over the period, that is a drop of over 10% in the real value of your home!
The writing it seems is on the wall, but not for the BoE. They were asleep at the wheel in 2021, slow to wake up in 2022, but now grabbing the steering wheel so hard the economic car is veering from heading toward a ditch, to being driven straight into a brick wall. Less rear-view mirror watching please. Would it be too much to ask to look at the road signs ahead?!
So, how is this affecting the investment world in the UK? Well, it is causing something called a ‘cash trap.’ When a ‘cash trap’ occurs, investors feel safer holding onto cash. After all it is getting a good rate in the bank. Mortgage costs have skyrocketed. So, pay that debt down. No argument, it makes total financial sense to do that. But that money comes from somewhere. Bank deposits are falling, bond markets are falling, stocks already lowly valued are sold further down. Why risk your money when your bank account gives you a decent return?
The ‘trap’ is triggered when expectations turn. When an inflation statistic or throw-away comment from a Bank of England chief suggests rates will not keep going up, the equity markets jump quickly and sharply higher even as economic growth looks poor. That 4% cash return in the bank suddenly looks less appealing.
So here at MVAM you might have detected a more positive tone to our newsletters of late. We may not be out of the woods over the longer term, but to paraphrase the lyrics from another 60’s song ‘there may be trouble ahead’… but ‘before they ask us to pay the bill’ …. the markets are likely ‘to face the music and dance’.