As the third quarter began, investors were concerned that inflation was even more deeply embedded than originally thought, and at one point some commentators were predicting peak interest rates of 6.5%. We did not agree with that narrative. We were proved right in August, when presented with a smaller 0.25% hike. The following month, a very minor 0.1% fall in manufacturing revival gave the Bank of England (BoE) enough cause to keep rates as they were. This brought an end to 14 straight months of rate hikes and signalled the end of this cycle.
A lot of market commentators had been expecting further action from the BoE to dampen inflation and calm the spending profile of the UK. The resilience of both the economy and the labour market had supported this consensus. We were already aware of how strong the UK economy is, given how well it has held up since the pandemic and the fact inflation has not yet fallen meaningfully this year.
The fund recorded some net outflows during this period, but we managed to accommodate these without having to sell any assets. In September, we were able to take advantage of a tranche of new covered floating rate note issuance, swapping out of shorter positions for others where we could generate more yield. As we also saw potential for interest rates to be rounding off, we decided to buy one fixed-rate asset, a July 2028 bond from the Bank of America yielding 5.64%.
We expect the BoE to hold rates where they are, based on the underlying inflation picture. Food inflation figures are down considerably in 2023, which suggest core inflation may fall over the next quarter. If the BoE recognises it is only making gradual progress with inflation, it may be more likely keep rates high to stay the course. Given the upheaval of 14 straight hikes, it is likely that the BoE will want to stabilise the situation and provide some security to households, businesses and the markets. We believe that only when inflation is under control and forecast to stay in the target 2% region will the bank have the best opportunity and justification to start cutting rates. The last thing it will want is to give mixed signals to the market, and inadvertently cause inflation to pick up again.
Due to the fact the WS Canlife Sterling Short Term Bond Fund was launched shortly before the eventful 2022 Jackson Hole summit that saw bond yields rise sharply, the portfolio has a lot of assets in it which are ‘underwater'. We are looking to reposition the fund with longer-dated assets where we can, particularly looking at switching existing covered bonds into new issue covered bonds. At launch, we also bought an array of short-term covered bonds on the secondary market as the spreads have been lower than those available on the primary market. We will continue to refresh those as and when opportunities arise.
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
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Promotion approved 18/10/23