Bonds and Brexit – Tighter sooner? Brighter later?

Guest blog: Latest outlook from Alastair Gunn and Rhys Petheram Co-managers of the Jupiter Distribution Fund Range

We expect global economic growth to remain subdued this year as the initial exuberance about the so-called Trump ‘reflation trade’ is tempered by a growing realisation of what is achievable in practice – at a time when financial conditions are expected to be tighter in the US and China.

In the UK, we expect the impact of Brexit will be on the long-term growth rate rather than on the near-term economic cycle. Overall, we expect a weak outlook set against a backdrop of gradual, guided slow tightening monetary policy. In our view, unlike in the US, markets have not currently discounted the possibility that the Bank of England might tighten policy given that base rates remain at extraordinarily low levels.

For example, the gilts market is not pricing in any UK rate rises as far as the eye can see with cash forwards being priced out to about 2019 with zero expectations of a rate rise. Although we are still reasonably pessimistic on the growth outlook for the UK, we are not as pessimistic as the market, i.e. we think there is some scope for tightening in the UK over that time horizon. Furthermore, even without a rate rise, there is still space for some release of the term premium1 if UK economic growth turns out to be better (or less bad) than is currently priced in.

From an equity perspective, the European Central Bank finally appears to have achieved some small success; its quantitative easing (along with reasonable global growth) has helped to create a cyclical economic upturn in the eurozone, particularly in the northern members, although Spain has been growing strongly too. We think that the UK economy (as a major trading partner) should enjoy a bit of tailwind from this. With the uncertainty of the French election gone, we would expect investors to be more inclined to concentrate on the improving economy, indeed that’s one reason why global capital flows have been directed towards Europe in recent months in anticipation of a decent reporting season. We hold a number of companies which could benefit: IAG, Mondi, Midwich, Playtech and Ryanair.

In the UK, success in the snap general election could enable the Prime Minister to deliver a softer Brexit that would be less damaging to long-term economic growth prospects and rekindle interest in domestic equities.

You can find more information about the Jupiter Distribution Fund Range here

Alastair Gunn and Rhys Petheram

1: The term premium is the additional yield beyond short rate expectations that investors require to own a bond for a duration beyond the immediate future. The term premium essentially reflects the risk that investors’ embedded short rate forecasts are incorrect and the compensation that they may require for that risk.In 2013, the taper tantrum seen in US bonds was a term premium release.

Important Information

This document is intended for investment professionals and is not for the use or benefit of other persons, including retail investors.

This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Past performance is no guide to the future

The fund can invest up to 10% of the portfolio in high yield bonds and can also invest in bonds which are not rated by a credit rating agency. While such bonds may offer a higher income the interest paid on them and their capital value is at greater risk of not being repaid, particularly during periods of changing market conditions. The level of monthly income payments may fluctuate.

The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. A portion of the fund’s expenses are charged to capital, which can reduce the potential for capital growth. This fund can invest more than 35% of its value in securities issued or guaranteed by an EEA state.

The views expressed are those of the author at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Company examples are for illustrative purposes only and are not a recommendation to buy or sell.

Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority.

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