I refuse to pay German and Japanese governments for the privilege of lending to them
John Redwood
I cannot bring myself to buy sovereign bonds offering negative yields. It’s a crazy world where people will pay the German or Japanese government for the pleasure of lending to them.
Presumably investors who buy bonds offering a guaranteed loss if you hold them to redemption do so because they expect to sell them to someone who pays an even more ludicrous price well before the bond is repaid. I would find it impossible to explain why I had bought such bonds if they went wrong and sanity returned.
Time was when investors bought government bonds for income and shares mainly for capital gains. Now they buy good quality bonds for capital gains, and can pick up a decent income by buying shares. The FT fund has avoided Japanese and euro debt because it offers such a bad deal. The longer dated UK debt the fund does hold has performed more like a riskier equity in a bull market this year. Even the more cautious shorter dated UK debt the funds owns has seen buying interest push some prices higher. The bonds are in the fund to provide some stability but have done more than that.
Logic tells you that this extreme pricing of many bonds cannot last, that there is something irrational about people holding bonds with no income when the main purpose of a bond should be to pay you a bigger income than cash. History, however, tells us that markets can persevere with ultra-low interest rates and negative rates for many years if the authorities are determined to drive rates down and keep them down in a low inflationary environment — the period following Japan’s banking crash of the late 1980s being a case in point.
The world’s main central banks are fuelling this bond euphoria with their words and actions to cut interest rates and their wish to create easier conditions. The bond markets have pushed short-term interest rates higher than some longer-term interest rates, and then claimed this proves there will be a recession. Recessions usually mean higher bond prices and interest rate cuts to try to get things going again. I see no early recession in the US nor in China, and expect the euro area as a whole will scrape by without quite entering one.
The fear of recession powers the bond market and is forcing central banks to do more than they otherwise would to promote growth with easier money. Some bond market practitioners have in the past forecast more recessions than we lived through.
The curious thing is the absence so far of serious inflationary pressures in the advanced world.
When Argentina and Venezuela try their extreme policies of large budget deficits and printing more money their currencies collapse and inflation takes off, just as pre-banking crash theory tells you it should.
Since 1990 Japan has built up a huge state debt, now 250 per cent of its national income, and created vast quantities of yen to buy in around half this debt. Inflation remains stubbornly low and the currency periodically takes it in its stride. Between these two extremes lies the rest of the world.
The Fed admits it does not fully understand current conditions and has spent recent months trying to work out what is the new normal. It does not know how low unemployment can fall before there are serious inflationary pressures. It does not understand why the US economy can approach what it thinks is its capacity without serious inflationary problems emerging. It would like to know if there is a new normal interest rate to aim for. We await clarification of what will guide future rate changes, at a time when markets are insistent that the Fed must cut more to see off low or no growth.
The FT portfolio attempts to reflect the new realities. One of the pressures keeping inflation down is the digital revolution. Another is the global marketplace. The US, UK and other central banks have tried to run their policies based on the idea of national capacity, but they need to look through national supply to the global market.
If the US and UK run out of home labour, migrants appear to take the jobs. Alternatively, some work is supplied from abroad with a high labour content met from overseas-based employees. If the US or UK hit the ceiling of the domestic economy to supply any given item a foreign version arrives rather than allowing the home producer to put up prices.
In this world, the revenues of the global winners grow more quickly than the businesses they are attacking. Revenue and profit transfers from traditional models and companies to internet-based ones, forcing traditional business to adapt or die. Maybe one day the fairly rapid growth of US money will filter through to faster growth in domestic wages, as there are areas where the economy is dependent on domestic labour with the right training and it is in short supply. That will cause issues for the Fed as it strives to meet some of the expectations for lower rates.
Meanwhile, good money growth in the US and the success of US technology companies has served this fund well.
The fund is still up by 12 per cent this year despite the sell-off recently in share markets prompted by the intensification of the Trump trade war. These tensions are causing some damage to confidence and trade volumes, but more of the slowdown results from policy decisions of the Chinese, the euro and other leading central banks and governments.
Sterling now looks cheap, so I am increasing the amount of currency cover on the US holdings. The fund has not been exposed to euro area risks in recent months, where assets have been underperforming thanks to the slowdown, the structural problems of the motor industry hitting Germany, and the continuing budgetary problems in various member states.
Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing.
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