'Truss needs emerging market medicine to fix our developed economy'

British Prime Minister Liz Truss
British Prime Minister Liz Truss

Mark Nash, co-manager of the Merian Global Strategic Bond fund, says a tug of war is going on between the Bank of England and the Government.

The Bank needs to temporarily dampen economic growth to get inflation down, while the new Prime Minister and Chancellor are trying to boost growth.

This war is in full flow following Kwasi Kwarteng’s disastrous mini-Budget last week, which sparked the biggest fire sale of the pound and British government bonds in almost 35 years and a drastic intervention in the bond markets by the Bank.

It tops off a challenging nine months for those bonds, also known as gilts, as prices have plummeted and yields have risen to levels not seen since 2008.

Mr Nash, who started to run the £260m fund in 2016, buys a range of bonds and has navigated the market well: his fund has returned 2pc over 12 months against an average loss of 14pc among rival funds.

While inflation may be peaking, Mr Nash says he suspects the path down will not be straightforward. He also explains why bonds issued by commodity-producing emerging markets have never looked so attractive.

How do you invest?

We are “macro” fund managers. We take views on levels of economic growth and inflation because these two factors drive interest rates up and down.

As well as buying highly-rated government bonds we have the flexibility to “short” bond markets using derivatives and make profits if prices fall. We do this if we think bond yields will rise, for example, as central banks raise interest rates.

How are you responding to rising bond yields?

We have been negative on developed market government bonds this year because global resources have gone up in price. The Bank of England has had to increase interest rates to control inflation and to stabilise the currency because sterling is falling.

We think interest rates across the world could go up a lot further than people expect. In Britain 5.5pc is a very reasonable target for interest rates. You have a central bank that needs to get inflation down, while the Government is introducing measures to boost growth, so there is a tug of war between the two.

This is why we are negative on developed market bonds and think central banks will raise interest rates higher than we have seen in the past.

How do you express this view in the fund?

We have “short” positions in the bond markets where we think domestic economies look “hot”, such as the UK. We are wary of gilts, European government bonds and US government bonds with maturities of two and five years. The latter have experienced price declines.

Are you positive on any bonds?

We like government bonds from emerging markets issued in their domestic currency. I have never seen certain emerging markets look so good compared with developed market bonds.

Commodities and energy are the scarce assets at the moment so if a country produces them they are in a great position. Places such as Brazil and Indonesia are looking great compared with Britain and Europe, which is why we like their bonds.

Post-Covid, we are no longer in a globalised world where you can find things easily and cheaply. This had kept Western bond yields down, inflation low and economic growth weak.

Now we are seeing the developed market bond bubble burst. You cannot cut out the world’s largest fuel producer, Russia, from the global economy without every­thing getting more expensive.

Why are UK bonds in such a mess?

Britain’s problems are high inflation and a deteriorating trade balance because we import more than we export. You cannot spend your way out of this: the central bank needs to raise rates and lower growth, or you risk financial instability.

The fall in the pound and rising bond yields reflect a lack of confidence that these problems are being addressed by policymakers. What we have seen in the past week is emerging market medicine for a developed market economy.

I think inflation is near the peak or may already be peaking. It is expected to come down quite smoothly over the next year or so in the major economies.

The central banks, for the most part, have their credibility back. It may be quite easy to get inflation down to 4pc-5pc but after that it will be a lot more difficult, so central bankers can’t relax.

The problem is, we think, that the economy has got all this demand ready to go. If the central bankers relax, this demand will cause inflation to come back.

Are we approaching peak inflation?

I think inflation is near the peak or may already be peaking. It is expected to come down quite smoothly over the next year or so in the major economies. The central banks, for the most part, have their credibility back. It may be quite easy to get inflation down to 4pc-5pc but after that it will be a lot more difficult, so central bankers can’t relax. The problem is, we think, that the economy has got all this demand ready to go. If the central bankers relax, this demand will cause inflation to come back.