The UK macroeconomic backdrop remains fraught and uncertain. The government is grappling with a ‘black hole’ in its finances and further tax rises are expected in the Autumn Budget scheduled for 26 November1.
Rising levels of government debt continue to put pressure on borrowing costs – which are at their highest levels since the 1990s – while ongoing global trade tensions threaten to place a further drag on growth. In the second quarter, the UK’s economy expanded 0.3%2, while the unemployment rate rose to 4.8% in the three months to August3.
The lacklustre economic conditions continue to bolster the appeal of sterling-denominated money-market funds (MMF), which seek to preserve capital and maintain daily liquidity, while offering a competitive yield. Sterling MMFs have gained sizeable inflows in recent years and assets stood at £290bn (€334.9bn) in September 20254.
Figure 1: UK money market assets vs. BoE rates
Inflation, meanwhile, remains stubbornly high – UK CPI held steady at 3.8% in August – making it less likely the Bank of England (BoE) will cut rates in the final two MPC meetings this year in November or December.
The BoE opted to keep rates unchanged at 4% in September. The Monetary Policy Committee (MPC) voted 7-2 to keep rates on hold but two dissenters – Swati Dhingra and Alan Taylor – pushed for an immediate 25bps reduction. The split is indicative of the high degree of uncertainty about the direction of the economy. (In August, a three-way split forced the MPC to vote twice, before the central bank finally announced a 25bps cut.)
A question of duration
The typical response of investors during a rate-cutting cycle is to extend duration and seek higher-yielding debt further out the yield curve – and in the last few months we have seen exactly that, with leading money market funds extending their weighted average maturity (WAM). However, stubborn and sticky inflation continues to tie the BoE’s hands and the central bank has reduced rates far more slowly than might have been expected a year ago – and we believe that will only benefit sterling-denominated money-market funds from here.
The consensus expectation is that the BoE will begin easing again in March as long as the November Budget doesn’t lead to unexpected market ructions.
Figure 2: Implied overnight rate and number of forecast BoE hikes/cuts
In any falling rate environment, MMFs can potentially offer additional benefits, providing ‘carry’ on higher rates (compared to sovereign debt, for example) while at the same time also providing all-important daily liquidity – allowing investors ‘same day’ access to their cash.
Wider global pressures
The wider global outlook – amid rising levels of government debt in many developed countries – is likely to put additional pressure on long-term sovereign debt yields. In the US, President Donald Trump’s sweeping tax and spending reforms are forecast to add more than US$3tn to the national debt pile over the next decade5.
Further volatility at the longer end of the curve is widely expected in the near- to medium-term – including in the gilt market – and many investors anticipate further rises in long-term gilt yields in the coming months.
Further volatility at the longer end of the curve is widely expected in the near- to medium-term
While the initial fallout from the scattergun US rollout of tariffs may have abated, many of the UK’s many domestic pressures remain unresolved and we believe this will likely encourage a more short-dated approach from credit investors.
Consumer confidence, for example, has stagnated in the UK, according to a leading index6, on the back of elevated inflation and slowing earnings growth, leaving many people worrying about their household finances. With the autumn Budget approaching, speculation around potential fiscal measures is likely to inject further volatility into household sentiment.
All of the above helps explain why flows are increasing into sterling MMFs where the primary objective is capital preservation – achieved through investing in a diversified pool of highly-rated, short-term debt securities in order to achieve a competitive rate of return – no matter how volatile the underlying markets in the UK, and elsewhere, prove to be.
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2 Office for National Statistics
3 Ibid.
4 Federal Reserve Bank, St. Louis / Morningstar
5 US debt is now $37tn – should we be worried? – BBC News
6 No overall change in consumer confidence in September | News | Research Live
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