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US Rate Rise – A Warning to Bond Holders

| Investment | By Gary Reynolds

Hello everyone,

If you are amongst the 300 that attended the Courtiers Annual Seminars on the 8th and 11th December, you’ll be aware that I predicted that US interest rates would go up and Janet Yellen obliged yesterday. I was somewhat relieved, particularly as apart from talking about the interest rate increase at the seminars, we also published a note saying a similar thing on the 15th December.

Why did US interest rates go up – the first rise in nearly ten years? The reason is that the economy across the Atlantic is doing quite well. Car sales are up, unemployment is down, housing starts are up and the consumer in America is starting to spend some of the windfall that they’ve got through having lower costs of filling up their car with petrol or heating their houses. The reduction in oil prices is really good news for consumers. But there are consequences and we need to be aware of this.

In the UK we have a base rate of 0.5% and it’s been like that since 2009. Since the Bank of England came into being in 1694 we have never had a period of such low interest rates or for so long. If the economy returns to anything like normality that will change. If you own a 30 year gilt the interest rate is around 2.6% - very low for having an investment that’s got a 30 year time horizon. Historically the average return from 30 year gilts is a lot higher and the base rate in the UK over the last 100 years has been just over 5.5%. This is what everyone needs to bear in mind; if the long term yield on that 30 year bond returns to something around 4.5% - still lower than long-term UK average base rates - the holders will lose nearly 30% of their capital. That is equity type risk in the bond market and that is why we are keeping our bond durations very, very short as things begin to change.

We will write about this a little bit more shortly, but in the meantime I hope everybody has a fantastic Christmas and a very peaceful and prosperous 2016.

Gary Reynolds CFA

Chief Investment Officer

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