The value of UK government bonds (gilts) and US treasuries are falling – investors are selling government bonds because their low fixed returns look unattractive in a world where inflation and bank interest rates are higher.
Inflation is public enemy number one
Inflation is a deterioration in purchasing power that occurs over time. The purchasing power of money erodes with inflation since a pound (or any other currency) will go further today than it will at some future date.
Inflation reduces the value of a bondholder’s coupon interest payments. The longer the maturity of the bond, the more pronounced the inflation effect.
This surge in inflation concerns has been driven by the continued global supply bottleneck for goods, raw materials, energy, and labour. However, since the pandemic, many of these markets have now adapted and started to regulate themselves with increased supply.
Inflation is the US
Wall street stocks and government bonds prices fell on Thursday after data showed the rate of US inflation hit a 40 year high in January of 7.5%.
With higher rates, and therefore higher borrowing costs on the horizon, US stocks tumbled.
What sectors have been hit hardest?
So far this year, tech companies have been among the biggest losers. Tech companies typically need fast-growing economies to do well, whereas investors are expecting the Fed to try to slow down the economy with interest rate increases in order to curb inflation.
Higher interest rates also make certain companies such as technology less attractive to investors because the highest borrowing costs can reduce future profits.
The “consumer discretionary” sector is also hurting, as uncertainty surrounding the spread of the omicron variant is raising concerns that people will stop buying what are considered non-essential goods and services, such as cars or meals at restaurants.
What rate rises are expected?
A rate rise is usually good news for savers who might be able to get a better rate. But it’s not such good news for borrowers who haven’t fixed the rate they’ll pay. Or for bond investors as interest rates rises usually mean falling bond prices.
Ultimately, higher interest rates make it more expensive to borrow money. This encourages people to save more and therefore spend less in the economy, lowering demand for goods and services. This helps keep price rises in check. However, if rates go up too quickly, it could derail the recovery achieved so far by hitting investment and growth.
What can you do as an investor?
Please get in touch with one our regulated financial planners to review your arrangements. It is important to assess the suitability of the amount you have held in cash and you have the correct asset allocation for your investments during these times of increased inflation.
Written by Alex Palmer DipPFS, IFA at Beesure Ltd