The strength in the bond market in August reversed in September, simply reflecting more hawkish talk from central banks rather than any improvement in hard data. Yields on ten year Treasury bonds rose from 2.12% to 2.33% as the US Federal Reserve outlined plans to normalise its balance sheet and reduce its holding which amounts to around 12.5% of the whole Treasury market. Whilst we have no doubts that normalisation will take place, it is likely to be a long process which will be measured in years. The outlook for interest rate hikes looks optimistic, given pressures on growth and inflation. In the UK, ten year gilt yields increased from 1.08% to 1.4%. Although the Bank of England voted 7-2 against hiking rates, the tone was more hawkish in reflection of a surprise increase in inflation to 2.9% in August. However, it is clear that the inflation is not domestically generated, stemming from the decline in sterling and rise in oil prices. With markets now expecting one increase in interest rates in Q4 and another in H1 2018, expectations are now high. UK rates have not increased since 2007 and any increase would represent a career first for the incumbent Governor of the Bank of England.
Despite the widespread assumption that interest rates would rise imminently, there was little reaction in the commercial property market over the month. Of our preferred holdings, the F&C Commercial Property fund declined by 0.8%. The iShares MSCI Target UK Real Estate UCITS ETF, a trust composed of listed REITs and short dated index linked gilts to add liquidity, fell 0.4% on the month. The listed REITs sector offers significant discounts to NAV.
Gold experienced a challenging month, dropping 1.44% as investors priced in an increased likelihood of coordinated tightening of monetary policy across the globe, making non-yielding alternatives less attractive to cash. However, in US dollar terms, gold remains 11.6% up in the year to date as numerous uncertainties remain over the fate of the global economy and the reality shows that growth continues to slow. With weakness in gold and fixed income, it was a difficult month for our preferred Total Return Funds. The Newton Real Return Fund fell 0.6% with the Troy Trojan Fund down 1.1% on the month. The infrastructure sector weakened as expectations for interest rates declined. HICL Infrastructure, our core pick, dropped 3.9%. We note that it now trades at a premium of just 4.4% to NAV, with the shares close to a two year low, providing a solid yield of 4.9%.
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