Cowley warns UK faces 'quiet crash'
Old Mutual's veteran bond investor is reducing his sterling exposure, shorting gilts and adding inflation protection.
by Matthew Goodburn on Feb 14, 2013 at 11:00
Veteran Old Mutual Global Strategic Bond manager Stewart Cowley has warned that the sterling currency is likely to come under sustained pressure as the interest payments needed to service the UK's public debt start to spiral.
He says the UK's currency faces a 'quiet crash' as it loses its safe haven status as macro worries ease, and the market refocuses on the UK's debt and growth issues.
Cowley warns that with inflation continuing to rise, servicing the UK's budget deficit is also set to get more expensive.
'The rate at which interest payments by the UK government are rising is alarming. It is £50 billion now and it will be £52 billion by 2014. But if we continue to run the deficit at £150 billion, with gilt yields at 2% that deficit very quickly goes above £75 billion.'
To counter this, he has been reducing his sterling exposure, shortening his duration on corporate bonds and has taken out short positions against UK and US government bonds as well as against Japanese and French sovereign debt.
Around 4% of the £870 million fund has also been switched into US dollars 'because it is not the pound' while index-linked bond exposure has been increased evenly between US and UK linkers to deal with the inflationary environment. Exposure to the euro has also been increased although Cowley remains 'agnostic about which currency will win against the sterling'.
US and Japan control the euro
Cowley thinks the euro's steady rise in recent months has also been overlooked by many, but that ultimately it will be the US and Japan that will 'dictate' the end of the euro's strength when QE and attempts to devalue their own currencies end, although there is little sign of that happening for some time.
He said: 'A lot of people wrote off the euro but we always said that once there was a credible backstop [which came with Mario Draghi's comments last summer] we would invest. Since the market has swung away from safe havens it has brought sterling down because we have fundamental problems with our own economy.'
'The G7 said it would not have a currency policy which allows the euro to continue to rise. While the US and Japan will dictate its end, the US shows no signs of stopping QE and Japan is devaluing its currency.'
With the Bank of England continuing to indulge in what Cowley terms 'pure electronic money creation' he believes that inflation is already ahead of the official headline numbers, and that investors are sleepwalking into losses as they hold on to gilts that are losing them money in real terms.
He said: '[UK] Inflationary expectations have been rising since July and we have had 38 months of missing our [2%] inflation target. People should realise inflation is already here and official figures do not reflect ordinary people's experiences.'
'People are looking through the consequences of the money printing and wondering "where will it end?" There is already evidence that [QE] is already leaking out into the wider economy. We should stop it now.'
Cowley thinks a rapid rise in retail deposit money flowing out into the economy as well as a big jump in first time house buyers and the return of 90% mortgage loans all point to excess liquidity at a time when house prices are already '25% overvalued and even more in London.'
'We have £375 billion of gilts sitting inside the Bank of England vaults which means 40% of our gilts are owned by our own central bank which was never designed to do this. Our government is stuck. It cannot extend borrowing much further - it has barely touched the debt and look at the problems it has caused.'
Cowley things the only route out of the predicament is a devaluation of the currency, and he thinks sterling, along with the US dollar further out, are most vulnerable to sustained falls in value.
'The UK and US are two countries most prone to a devaluation. There are big cultural differences between the two compared with Japan and Europe.'
'The Europeans recycle other people's money as the Japanese do, but the US and UK actually print money and the UK is worse than the Americans, having indulged in pure electronic money creation.'
Over five years to the end of January, Cowley has returned 75.7% compared to the CitiGroup WGB TR GBP return of 54.4%.
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by Chris Sloley on May 17, 2013 at 14:45