If there is one thing the markets hate, it is uncertainty – and it is hard to think of a more uncertain UK general election than the one that is just around the corner.
But it is not political risk that should be dominating the macro agenda for investors looking to capitalise on the growth of the UK economy.
Investors may well be asking whether this election’s uncertain outcome will have a significant impact on the long-term value of any UK investments. I do not believe it will. It certainly will not make nearly as much difference as the other uncertainties currently permeating global markets, such as the strength of the US recovery and the reaction to the first US rate rise.
On the face of it, the question of Britain’s future relationship with Europe stands out as one exception to this argument. It is extremely important to the economy – especially the City – and it marks an important dividing line between the Conservatives and Labour.
The other big wild card in 2015 is the pound, which has been pulled in both directions. It is possible that political uncertainty will dent sterling’s rise against the euro, at least in the short term. But the underlying strength of the UK and the prospect of higher UK interest rates will increase the likelihood of some further appreciation against the euro.
When it comes to the timing of UK interest rate rises, the story continues to evolve. Markets have gone from expecting the UK to raise rates first, around the end of 2014, to expecting little or no UK tightening before 2016. Expectations of a US rate rise have also been pushed forward, but some tightening is expected before the end of 2015. Markets had clearly got ahead of themselves last year.
On balance, it looks like the Bank of England is likely to move after the Fed, but in both countries this is a data-dependent story. With more upward movement in UK wages than in the US, it is even possible that the relative order of rate rises will change again.
The key point for investors is that the date of the first rate rise, in either economy, is much less important than the subsequent pace. The UK is likely to move much more slowly than in the past, and more slowly than in the US.
With the first rate rise expected in the UK by early 2016, fixed income investors need to prepare for this prospect. This means keeping a close eye on the wage and productivity data that will guide the BoE’s decision-making. But the pace of tightening and the ultimate destination will be more important for returns than the date of the first increase.
Even with rate rises at the short end, structural demand at the long end of the bond market will continue to support bond prices and act as a ceiling for long-term gilt yields.