“This is not how quantative easing is supposed to work” says Kames Capital as it calls for coordinated monetary and fiscal policies

2nd September 2016

A unified front from policymakers is needed to tackle the pressing issue of record low bond yields, which have tumbled since the EU referendum result says Kames Capital’s chief investment officer Stephen Jones.

Two months on from June’s Brexit vote, the resulting cut in the UK’s base rate to 0.25% and the expansion of quantitative easing has had a profound effect on certain asset classes, boosting valuations for both UK equities and UK government bonds.

However, while in the short term it may have lifted asset prices, it has also left bond yields uncomfortably near to zero, and Jones said policymakers now needed to work closely together to tackle this challenge and its wide-reaching impact on markets.

“Risk markets are feeling the love of benign policies, moderate economic growth, and much lower discount rates,” he said.

“The problem with these low yields, however, is that they intensify the pressure on large institutional balance sheets. The result has been yet another slip for solvency levels for pension schemes, which in turn intensifies the pressure on sponsors to direct earnings away from reinvestment in attractive future opportunities to lessening accrued deficits.”

Jones said collaboration was now needed by UK policymakers if markets are to continue to make progress. “Ultimately, this is not how quantitative easing is supposed to work, and if they are to deal successfully with the greatest set of economic problems in living memory, policymakers – monetary, fiscal and regulatory – need to act in unison.”

“We look for the autumn/winter to bring a fresh approach to the economic challenges we face and for markets to react favourably. But the stakes are high. Brexit, and the monetary policy response that followed, has taken bond yields to unprecedented levels and if we allow these yields to reflect, rather than stimulate, final demand, then the penalties will be severe.”

While equities and gilts have rallied strongly since Brexit, Jones added some areas are now presenting potential opportunities following referendum-inspired sell-offs.

In particular, UK commercial property has suffered from a sharp downturn in investor sentiment, and Jones said such areas now offer “genuine bargains” given the scale of the falls.

“UK commercial property prices, particularly in the South East, have suffered the most enduring and negative response to the referendum result,” he said.

“The initial ‘run’ on property funds, however, looks to have been an exaggerated reaction given the limited evidence from actual transactions. It is possible that the 20% mark down in some cases will prove to have been a genuine bargain.”

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