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As our minds start to focus on yet another round of inflation data and central bank rate rises in the coming week, our current thoughts are on the news that continues to come from China on the relaxation of their zero COVID policy. The prospect of home isolation, (remember those days), in China rather than mass quarantine in designated hotels along with dropping testing to attend public places must be a welcome relief and will hopefully help to calm some of the social unrest we have seen in recent weeks.
We must not be naive to think this initial news will immediately transform our views on Chinese investments and positively impact on Asian equities for a prolonged period, however along with a weaker US dollar, this is encouraging for investors in this region. This lockdown news needs to be countered by softer than expected Chinese growth figures in recent weeks and forecasts for the next 6 months are not encouraging, however the outlook after that period is interesting. As always with an eye on longer term opportunities, we have been back on the phone to our Asian fund managers after a summer break when the central states tough COVID measures forced a reduction in our exposure in the region.
It was interesting to hear from one of our favored bond fund managers – Mike Riddell at Allianz, who was querying who would step in to buy UK Government Debt (aka Gilts) once the Bank of England (BOE) starts selling them into the open market. The BOE currently owns more than a third of the UK Gilt market and is expected to be selling around £240bn of Gilts a year to unwind the £800bn Quantitative Easing scheme and correct a huge debt imbalance. Previous debt issuance to support the UK Governments expenditure have been hoovered up the BOE but now they are to become the sellers, so Mike questions who will step in to buy this debt and at what price. The UK Gilt market has recovered substantially since the September mini-budget with the cost of borrowing falling by a third and Jeremy Hunts November budget has indeed helped to calm foreign investors and go some way to making the UK investable once again.
Foreign investors in UK debt normally account for over 30% of the annual Gilt issuance in the market, but in recent years it has been less than 15%, according to JP Morgan. In a new world where the UK has distanced itself from Europe, we are reminded of the former BOE Governor Mark Carney who commented that the UK Debt market was dependent on “the kindness of strangers” – reflecting on our reliance on foreign investors to provide liquidity to the UK Government and to help balance the books. Falling UK Gilts yields are good for the Government, as these represent the interest payments on the debt they need to pay to holders of the Gilts, however on a global scale it could be argued that Gilts yields should not fall too much further to remain attractive to foreign investors. You could say there is a bit of a chicken and egg scenario developing.
Narrative matters. Jeremy Hunt has managed to get the market to accept his borrowing plans as we can understand the reasons why it is needed and there is an acceptable, if painful, plan in place. The outlook for the economy is not great currently and if the chancellor can continue to bring the markets along in his story of doing his best in difficult circumstances, brought on by external factors, then he may still have a convincing narrative to encourage foreign investors back to the UK market.
As we move towards the festive break, I have one more opportunity to write to you before Christmas and with your permission I will once again focus next Friday on inflation and central banks as next weeks inflation data is eagerly anticipated. Until then, good luck to England on Saturday night and please do have a good weekend.
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