Thursday, 08 March 2018 12:07

The Name is Bond…







  Eran Peleg, Chief Investment Officer 



The Name is Bond…



The word ‘bond’ reflects binding security, firm assurance.

For this reason, Dictum Meum Pactum (‘My Word is my Bond’ in Latin) was historically the motto of the City of London, the capital’s financial center. The Latin expression appears on the London Stock Exchange’s coat of arms. It originates from back in the days where financial transactions were made with no written pledges, no documents, and no contracts.

The financial instrument ‘bond’, an instrument of indebtedness, is normally considered to be a safe, secure, low-risk investment – especially if it is issued by a highly-rated borrower.

In addition to being considered as lower-risk investments, bonds have historically also played an important role in investment portfolio construction. They have often been a safe-haven at times of financial market stress. During these periods, as prices of higher-risk securities, such as equities, dropped, investors looking for safety pushed up bond prices – providing an offset against equity losses. Investors therefore incorporated bonds into their broad portfolios with a view that they act as portfolio diversifiers. This role is now being challenged.

Due to a prolonged period of zero interest rates and continuous buying of bonds by central banks globally, bonds yields are low (and their prices, inversely-related to yields, are high). This limits the upside for bond prices. Furthermore, given where we are in the economic cycle (advanced), long-term interest rate cycle (low and rising rates), and increasing US Treasury bond issuance (especially given the now-expected future US fiscal deficits), financial market sell-offs, like the one we just experienced, may actually be driven by expectations of increasing interest-rates – which are negative for both equities and bonds (as the cash-flows they are expected to generate are then discounted back to the present at higher rates).

It is therefore no surprise that in the February sell-off, the short-term correlation between bonds and equites turned positive, with their prices dropping in tandem. In the US market, for example, equities (S&P 500 index) fell by -3.7% and USD investment-grade bonds (Barclays US Aggregate Bond index) returned -0.9%.

Investors may need to rethink their approaches to portfolio construction and diversification.






Published in Insights
Monday, 06 November 2017 14:31

London Calling

EranP Eran Peleg, Chief Investment Officer




The ice age is coming, the sun's zooming in
Meltdown expected, the wheat is growing thin
Engines stop running, but I have no fear
'Cause London is drowning, and I live by the river

-        “London Calling”, The Clash


The Bank of England raised rates for the first time in a decade. The last time it did so was in July 2007, just before the Great Financial Crisis. Interest rates were very low since due to the deflationary, weak growth environment we have been in.



On the face of it, you would think that last week’s rate rise is therefore a positive sign that macro-economic conditions in the UK have improved.

Look again. Interest rates are going up because (CPI) inflation has risen to the 3% level, and unfortunately, this recent rise has little to do with increasing demand and an ‘overheating’ economy – but rather, with import prices that have moved up due to the Brexit-driven fall in the British Pound.

UK government bond yields and the Pound dropped on the rate hike announcement. This is quite unusual – typically, higher rates means higher bond yields and a stronger currency. In their response, financial markets are signaling that the UK economy is too weak to withstand higher interest rates. It is a warning that policymakers should pay attention to.

The Bank of England can claim that it is merely doing its job. According to the UK’s monetary policy framework (see:, the Bank’s primary objective is price-stability. Supporting/promoting growth is only a secondary goal. This stands in contrast to the US, for example, where these two policy objectives are of equal importance (often referred to as a ‘dual mandate’). It is clear that, given current conditions, this framework could lead to destabilizing economic consequences.

Within this framework, it is also determined that if the 2% inflation target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor (the UK’s Secretary of the Treasury) explaining the reasons for the Bank’s failure in achieving its main goal.

Given that this inflation miss is not the Bank of England’s fault (but rather a direct consequence of the Brexit decision) – just this once, can the UK Chancellor perhaps settle for a polite e-mail or a WhatsApp message…?! If he is concerned about economic stability, rather than focusing on formalities, his time would be better spent on re-thinking the UK’s monetary policy framework.



Published in Insights