With interest rates climbing and the Bank of England officially opining that recession is upon us, you’d be forgiven for thinking the worst is yet to come. But in fact, there’s evidence to the contrary.
There’s been a rapid change in the fiscal landscape these past few months. Inflation figures have shot out of control, yes, but interest rates have followed in their contrails and seem to be having the desired effect. While still formidable, UK inflation surprised to the downside in August, and the US figure dropped as well. Quite suddenly, people are starting to see interest credited to their savings accounts again. If central banks tread carefully, we may just stand a chance of putting out the inflationary flames.
It's possible this encouraging view might be doing equities a disservice. Expectations for third-quarter earnings are high, which seems at odds with central-bank rhetoric. Federal Reserve Chair Jerome Powell has plainly stated that pain is coming, both for companies and consumers. There’s a fair chance these favourable forecasts will lead to earnings misses.
Bonds are regaining their appeal
But if we look at fixed income, the situation is rosier. Yes, the asset class has had a less-than-enjoyable 2022. As a consequence, yields have risen quite significantly. The yield on a bond essentially comprises all the expected interest that you would receive on cash in the bank for the time period covering the life of that bond. The essential difference is that instead of being able to withdraw your money whenever you want, you lend it for a set length of time (maybe two or five years), which ultimately gives you a slightly higher yield, if a bit further down the line. Provided you hold the bond to maturity regardless of what happens to prices in the interim period, you get the yield that you initially signed up for.
A better way to grow your savings
If you have a specific goal in mind—say, you are saving for a wedding, school fees, or a big holiday with a scheduled date—then you can buy an inflation-linked bond that matures on that date. For example, the five-year inflation-linked UK government bond featured in the chart above guarantees a 1% return in addition to whatever inflation is over the next five years. So the savings you’ve invested in the bond preserve their purchasing power and also compound by 1%.
This investment represents a sea change in financial markets—for the first time since 2011, investors have a risk-free method of protecting their savings against inflation. Savers have the opportunity to earn interest while accessing financial instruments that can shield them from the corrosive nature of inflation without having to take risks in the stock market.
Investment View: What rising rates mean for UK households
Your monthly bills are fattening up for the winter. Turns out those government stimulus cheques were really more akin to a loan.
We’ve said it before and we’ll say it again: the source of the developed world’s rampant inflation is no big mystery. Yes, geopolitics has played a part; there’s no denying Europe faces higher energy costs largely as a result of Russia’s attack on Ukraine. Instrumental too was the effect interrupted supply chains had on manufacturing and production during the Covid pandemic. But arguably most disruptive was the phenomenon of central banks (namely the Federal Reserve) taking out their wallets as the global population took to their beds. Too much money was injected into the system, which allowed prices to rise with little disruption to spending. The chart below shows one measure of US money supply which illustrates just how much additional money has been created this century, with a particularly dramatic ascent during the past two years.
At the tail end of the line, a flattening is in evidence. This represents the interest-rate hikes we’ve seen in 2022 and a stabilisation in money supply as demand for loans and credit fades. If all goes to plan, this will alleviate the problem but create challenges for households in the short term.
Here’s what you can expect as we move through autumn and into the new year:
Your mortgage payments will go up, particularly if your mortgage is on a variable or standard variable rate, as these track the Bank of England’s base rates. It’s expected that homeowners with a £250,000 mortgage will see payment increases of, on average, £66 per month.
Credit-card payments aren’t necessarily linked to base rates, so there won’t automatically be a correlation between higher rates and heftier bills. Personal loan payments should have been pre-agreed and will remain the same as well. However, if you’re looking to take out a loan, do it now: future repayment plans will almost certainly be steeper given higher benchmark rates. After all, central bankers are looking to up borrowing costs in order to diminish demand.
If you’re nearing retirement, your state pension will be unaffected. But, depending on your personal circumstances and tax situation, annuities may now be more attractive as they often benefit from higher interest rates.
You may earn interest again. If you’ve faithfully stuck by your savings account, you should begin to see a bit of an increase in those small monthly deposits the bank makes. We’d warn, though, that while interest rates are rapidly increasing, they are not hefty enough to negate inflation. Investing is still a better way to grow your money.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Always consult your financial planner or portfolio manager before making financial decisions. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and is not guaranteed. Investors may not get back the original amount invested.