The UK’s largest asset manager has been buying bonds and selling equities in preparation for a “significant” economic downturn, warning that the Bank of England will be forced to tip the economy into a recession despite signs of cooling inflation.
Sonja Laud, chief investment officer at Legal & General Investment Management, which manages £1.3tn of assets, said this week’s slowdown in inflation is not a sign that the UK will be able to dodge a recession, while the labour market remains tight and the impact of higher borrowing costs has yet to feed through.
“It’s a big relief that inflation in the UK is lower than expected but if you look at the actual number it’s still very high and we should not forget this,” she said in an interview with the Financial Times. “We have no doubt that interest rate rises will slow down the economy because otherwise inflation will not come down sufficiently for central banks to take their foot off the pedal.”
Laud is positioning for a UK recession as part of a broader global downturn, including in the US, where a sharp fall in inflation has prompted widespread predictions of a “soft landing” for the economy. However, she said the UK housing market, where increases in BoE rates feed swiftly through to mortgage borrowers, was particularly vulnerable to higher interest rates.
While both UK government debt and stocks both tend to suffer in a rising rate environment, Laud expects fixed income to benefit from a renewed appetite for safety.
“Whenever inflationary worries are dominating the narrative you have a positive bond equity correlation, but when growth dominates you have a negative one,” she said. “In a recession our expectation is that bonds will work as they always have.”
Given the dramatic repricing of UK debt in recent months, Laud said she “likes gilts” and the firm has been buying recently, but warned that their appeal was more limited for investors who are not based in the UK.
“The attractiveness of gilts depends on whether you have to hedge the currency or not,” she said. “If you are not in the UK and you have to consider the currency it might not be that interesting.”
While gilts have led a bond market rally this week, sterling has fallen 1.7 per cent against the dollar from its peak on Tuesday.
Laud’s comments echo a wider trend of domestic investors turning to gilts to scoop up higher yields, while big international investors have been more cautious, fearing the country’s outsize inflation problem and uncertain policy outlook.
Figures from BNY Mellon, custodian to around a fifth of the world’s financial assets, show net inflows of £13.4bn for 10-year UK bonds this year, the majority of which are gilts, while cross border trades have seen net outflows of £6bn.
Laud added that political uncertainty in the UK had deterred foreign investors from investing in the UK, with questions around how post-Brexit relationships will impact trade flows prompting some investors to wait for more clarity.
LGIM is the UK’s largest defined contribution pension provider, and is preparing to implement chancellor Jeremy Hunt’s initiative to invest 5 per cent of such pension funds into unlisted equities by 2030. While Laud said this move would be “helpful” in attempts to revive the ailing UK stock market, she would “like to see an approach that covers all the other aspects as well”.
“We can definitely do more to provide the financing initially, but we need to make sure we provide the right environment for these companies to stay, to grow, to have the right labour markets, the right support tech structures — the whole framework matters before a company decides where to list.”