Evercore Pan Asset

The Governor of the Bank of England is still worrying more about output than prices. The inflation figures are still poor for the UK, with more price increases coming through from weaker sterling, and from companies determined to limit the damage of poor volumes to profits and cash flow. The Governor himself admits that price increases on the government’s chosen measure of CPI may well go above the target of 2% again when the VAT rate rises at the end of this year.

The Bank is speculating about negative interest rates or penalties on banks hoarding their cash. This is a strange question to be discussing, at a time when the Bank’s twin banking regulator, the FSA, is demanding more cash and capital from the banks in the interests of prudence. The banks are unlikely to increase their lending in the UK any time soon, because their Regulator wants them to strengthen their balance sheets. If the Bank of England wants faster loan growth they need to have a persuasive word with the FSA.

There is another reason why loan growth will be subdued or non-existent. Many people want to repay debt. They are frightened at the thought of losing their jobs, which might make loan payments impossible. They are concerned that the current very low interest rates sometime will come to an end, and worried that they will not be able to afford their large debts if interest rates go up too much. Many people share a new wish to be prudent, which will keep loan growth modest and spending under control. That in a way is exactly what the authorities wanted to achieve when they set out to halt the credit boom in 2007. Now they are concerned about the impact on jobs and output.

Policy makers are making slow progress in correcting the huge imbalances in the world economy. All experts agree that the saving countries need to spend more and the spending countries need to borrow less. Meanwhile, attention remains turned to whether the US can manage another bubble to keep world spending and asset prices rising. It is true that China and India are stimulating their own economies and generating more internal demand, which is welcome. It is also true that markets are now pricing in US recovery, leading to a stronger world economy, as the easy money finds its way into risky assets first.

Our combination of Asian equity and western corporate bonds in portfolios is generating a decent return in these conditions. Purchases of property ETFs are also working out well. These vehicles are moving ahead of improvements in western property markets, as the underlying shares were sitting on large discounts and generous yields even allowing for further falls in rents and capital values. We need to watch out for signs of monetary tightening, which would bring these strong markets to a halt.

There will need to be fiscal tightening by the high borrowing countries quite soon. If there is not, expect the strain to be taken first on the exchange rate, and subsequently on the interest rate, once quantitative easing programmes have ended. Government bonds prices in the US and UK are what the authorities want them to be. They cannot carry on doing that for ever. At some point they need to stop buying and give the market a bigger say in settling the prices and yields. We still advise avoiding US and UK government bonds.