Blog Safety in Numbers: Why the UK Economy No Longer Looks Like an Outlier Many thought the UK economy was exceptional, but it has now converged – a timely reminder that, for investors, it pays to look under the bonnet.
Rewind a few months and some people feared the UK was a global outlier. Core inflation was running at close to 7% in May, in year-on-year terms – almost two percentage points above that in the euro area and the US at that point. Worse, underlying price pressures appeared to be accelerating, while activity remained depressed, with GDP still below its pre-pandemic level and underperforming the post-pandemic recovery in almost all other developed countries. At face value, the UK seemed to suffer from structurally higher inflation. Many blamed Brexit or other supply shocks, including a fall in labour participation, while others pointed to a lack of monetary policy credibility. At one stage, in early July, financial markets expected the Bank of England (BOE) to hike its policy rate to around 6.5%, well above that in the US and the rest of Europe. The UK seemed different. But there were good reasons to dig deeper. Small open economies tend to be more vulnerable to external shocks and experience higher inflation volatility. Indeed, other small open economies, including Sweden, Australia, and Norway, faced similarly high inflation rates. While Brexit might have added to consumer prices, this was likely a one-off level adjustment, rather than ongoing inflation. Most importantly, monetary policy credibility seemed intact, with medium-term inflation expectations anchored around the inflation target. Although the BOE’s communication at times appeared dovish, its actions were conventional and hawkish, responding to higher inflation with repeated hikes in the policy rate. Fast forward to today, and the UK no longer stands out. Granted, in year-on-year terms, core inflation remains higher than in the US and the euro area. But sequentially, inflation is falling sharply, even more so than elsewhere. Annualise the last three month-on-month prints (in seasonally adjusted terms), and core inflation is now even back to the inflation target. It’s a similar story with wage growth, which remains high at approximately 7-8% year on year, but sequentially has been falling recently. When annualizing the last three month-on-month prints, wage growth in the private sector is closer to 4%. Meanwhile, the underperformance in activity was – it turns out – misplaced. GDP has been revised sharply higher and is now almost 2% above its pre-pandemic level, on par with France and Spain, even better than in Germany. No doubt, some smaller parts of the UK economy still struggle (manufacturing output is depressed; so too are exports, especially in goods) but the broader picture now resembles that of most other developed countries. But recent market volatility serves as a good example that investors can benefit from a global perspective to fixed income. Up until recently, in our expectation that UK inflation would normalise, we favoured UK Gilts over US Treasuries in our global portfolios, with the former yielding about 60 basis points above the latter. The market has repriced sharply since, with UK Gilts now yielding 20 basis points less than their US equivalent. As such, we have shifted to a more neutral stance from a relative value perspective, although from an absolute point of view, we continue to find both attractive. US duration – a gauge of a bond’s sensitivity to interest rate movements – in itself offers the potential for attractive returns and we also see very good opportunities in other regions such as Australia, Canada, and Europe. Still, the UK's journey from outlier to convergence reminds us that perhaps it can pay for investors to look under the bonnet.
Blog The Fed: Stuck On Hold for Now Despite the reacceleration of inflation and enduring labor market strength, the Fed remains focused on downside risks.
Blog Why Yield Matters Attractive starting yields underpin our constructive outlook for fixed income.
Viewpoints Will the True Treasury Term Premium Please Stand Up? Various methods to estimate this key bond market gauge differ on details but appear to signal rising investor compensation.
Insights Weekly Market Update Our Asset Allocation team comments on what’s moving markets and how the PIMCO GIS Dynamic Multi-Asset Fund (DMAF) is positioned.
Blog Europe’s Economy Facing Short- and Long‑Term Headwinds Despite its cyclical and secular challenges, we believe Europe is a good diversifier for duration in global portfolios.
Blog ECB: Eyeing a June Rate Cut While the European Central Bank refrained from declaring victory at its April meeting, a June rate cut seems increasingly likely.
Blog Persistent Inflation Pressures Could Delay Fed Action The March U.S. inflation report and other macro data will likely prompt a change in the Federal Reserve’s trajectory in 2024.
Viewpoints The End of the Dutch Defined Benefit Model: A Steeper Euro Swap Curve Ahead Pension reform in the Netherlands, which has the largest pension system in Europe, will have important implications for investors across the continent and could structurally change the shape of euro swap curves
Viewpoints Bond Market Outlook: Valuations Suggest Potential for Equity‑Like Returns With Less Risk High-quality fixed income assets may offer the best return potential in more than a decade along with diversification benefits as a likely recession approaches.
Viewpoints Global Bonds Q&A: An Anchor in Uncertain Times With a potential economic downturn ahead, we see an increasingly strong case for high-quality global bonds, which can offer potentially both attractive yields and renewed diversification attributes.