US DOWNGRADE LEAVES MARKETS UNMOVED BUT INVESTORS REMAIN CONCERNED ABOUT THE OUTLOOK

US DOWNGRADE LEAVES MARKETS UNMOVED BUT INVESTORS REMAIN CONCERNED ABOUT THE OUTLOOK

This week brought a surprise cut to the US government’s credit rating, while the Bank of England continued its tightening campaign with another 0.25% rate hike. Despite the howls of outrage from some commentators in the US, the ratings cut is a bit of a non-event as the lack of reaction of bond markets demonstrated. In the words of Warren Buffet: “There are some things people shouldn’t worry about. This is one of them.”

However, bond markets have been moving this week with yields on developed market government bonds rising again. But while yields seem to be rising in unison, there is a lot going on underneath the surface as economies show more signs of diverging. The UK’s rate hike was accompanied by warnings that rates will be higher for longer and wage inflation remains a crucial factor in future decisions. In the EU, growth remains weak and inflation remains sticky. In the US, strong jobs data means rates may have further to go and the government said it will significantly increase bond issuance. The sovereign downgrade may not be worth worrying over but bond markets are finding other things to be concerned about.

UK: BANK OF ENGLAND OPTS FOR SMALLER HIKE

The Bank of England has increased interest rates to the highest level in 15 years as it confirmed a 0.25% hike. The UK has continued to close the gap on the US as the Bank of England chose to increase at the 14th consecutive interest rate meeting to take the bank’s base rate to 5.25%. Following recent strong employment and inflation data, some investors were expecting a larger increase of 0.5% and the smaller hike caused the pound to fall against the dollar and euro and gilt yields have risen steadily.

Investor attention will now turn to the outlook for rates. Markets now forecast that UK interest rates will peak at 5.75% in the second half of the year. Recent data shows inflation is falling steadily and the Consumer Price Index dropped to 7.9% last month, from a peak of 11% in October. The Bank of England now predicts inflation will fall below 5% this year. However, Bank of England governor Andrew Bailey said he expects rates to remain high for some time and indicated that further hikes may be required if wage inflation remains high.

US: BOND MARKETS UNMOVED BY RATING AGENCY DOWNGRADE

Ratings agency Fitch unexpectedly cut the credit rating of the US government from AAA to AA following the political standoff over increasing the US debt ceiling back in June. The news generated a lot of commentary about what this may mean for US government borrowing. But, although equity markets were unsettled, the market for US government bonds was unmoved by the news. Bond yields have risen this week on both sides of the Atlantic, however, surprisingly strong jobs data later in the week had a greater impact as a very strong jobs market has the potential to cause the US Federal Reserve to keep hiking rates.

In contrast to the strong economic data in the US, the latest GDP update for the EU showed economic growth remains weak. GDP for the EU increased by 0.3% in the second quarter. This is an improvement on the previous quarter when there was no growth reported, but it is considerably below the 2.4% annualised growth for the US in the same period.

HOUSING: RESIDENTIAL PRICES FALLING AT FASTEST RATE SINCE 2008

UK house prices are falling at the fastest rate since the financial crisis. According to the latest update from Nationwide building society, property prices fell by 3.8% over the 12 months to the end July as higher mortgage borrowing costs deter some buyers. The cost of the average 2-year fixed mortgage has increased from 2.8% at the end of July 2022 to 6.85% this week, although several lenders have reduced rates slightly in the last few days.

Higher borrowing costs are contributing to a slowdown in house building but are not putting off buyers entirely. Builders merchant Travis Perkins said profits are down 31% as the number of homes under construction has dropped from 52,000 in the second quarter of 2022 to less than 38,000 in the first quarter of this year. Meanwhile, builder Taylor Wimpey reported sales below last year’s level but said there is strong underlying interest as buyers are taking on longer fixed-rate mortgages to deal with higher costs.