Too late to panic

Buy when there is blood in the streets is the famous 18th Century dictum of Nathan Rothschild. Today the financial and political equivalent is plain to see. A government with no clue how to finance its tax cuts, a Bank of England reduced to crisis intervention almost daily, and a tightening liquidity squeeze with double-digit inflation is about as bad as it gets. No wonder the markets took fright last week, and were hardly reassured.

Buying long-dated UK government securities at almost any time since 1976 had produced a handsome dividend alongside a tax-free capital gain as the prices rose and the corresponding yield fell, finally to below one per cent. This was widely considered the new normal in an era of plentiful capital and perpetually low interest rates. Governments everywhere could borrow as much as they needed, almost interest-free.

We know better now. Even before the reckless spending policies under the last prime minister, made worse by the blind dash for growth of his successor, the worm had turned. Where prices of government stocks had been supported by the Bank of England paying whatever it took to buy for its Quantitative Easing programme, the mere suggestion that it would soon be selling the stock back to picky buyers was enough to start prices falling.

Then came the bizarre spectacle of the Treasury’s Special Financial Operation, which essentially said don’t you fret about where we’ll find the money, we’ll tell you later. The markets tanked, the Bank of England was forced to intervene, the Institute for Fiscal Studies essentially said that it can’t be done. The sense of panic was palpable, reinforced by the mysterious phenomenon of Liability Driven Investment, which whatever else it did has increased the risk in the market for government securities.

As FT Alphaville pointed out, it was the Bank’s Executive which issued the intervention notices, rather than its Monetary Policy Committee, which sets interest rates and supposedly aims for 2 per cent inflation. Awkwardly, they are mostly the same people, which adds to the sense of unreality that they are talking to themselves. A long and nervy statement from an outfit called the Pensions and Lifetime Savings Association thanking the Bank for rescuing their members’ index-linked* stocks hardly helped. Small wonder that the market has not recovered.

Yet the yield on long-dated stocks is now 5 per cent, its highest since 2002. While inflation is in double digits, this may not look every attractive, but the forces keeping prices pushing up are fading, and a recession looks odds-on. Even with the strong dollar, the price of petrol is well below its peak, and there is a fair argument that the price of gas is also going down, now that Putin has forced the west to find other sources. Should it fall far enough, it’s even (just) possible that the domestic price cap will cost the government nothing.

The yield on gilts is often, erroneously, described as the “risk-free return”. As holders have discovered in the last few months, it is nothing of the kind. But at 5 per cent the return looks higher than the risk – and after all, the financial blood will not always be flowing in the streets.

*The slide in prices has ended the absurd situation where an investor in gilts could buy protection against inflation only in return for a guaranteed real-terms loss on his money. Following the week’s panic, linkers are now in positive return territory for the first time in over a decade. A guaranteed return of 1.5 per cent over 20 years after inflation (but before tax) is hardly going to make you rich, but it will let you sleep at night.

We’d like to comply, but…

They got a warm glow last autumn by signing up for the snappily-named Glasgow Financial Alliance for Net Zero, in the different universe that was COP26. Now, with COP27 looming, US banks led by JP Morgan are getting cold feet. The bankers are conspicuously not sending their top people, and they fret that by outsourcing the test of whether their loans are green enough to a United Nations body called Race to Zero, they risk entanglement with anti-trust laws.

Whether the bankers are genuinely concerned about compliance risk, or whether they are just fed up with being told by some climate change bureaucrats who they can, or cannot, lend to, is not clear. There seems little doubt that the vilification of the oil industry has cast a chill over lending for anything to do with hydrocarbons, forcing the borrowers to look for secondary sources and leading to a drop in new projects. Whatever, JP Morgan is still the biggest supplier of loan finance to the industry and plans to go on lending while explaining how much it would like to comply with the racing zeroists. A clear case of cakeism, if you like.

In this week’s Podcast of A Long Time In Finance, Jonathan Ford and I talk to pensions expert John Ralfe about the mysteries of Liability Driven Investment, to find out why it has all gone so terribly wrong. On Apple or Spotify

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