In today’s Exponential Investor

  • The direction of the UK economy
  • The direction of the yellow metal
  • The direction of a certain crypto-currency

A lot of market commentators were surprised when the Bank of England’s Monetary Policy Committee (MPC) decided at its meeting on 2 November to keep Bank Rate unchanged at 0.1%, rather than increasing it.

The Monetary Policy Summary which accompanied the announcement of the decision was downbeat and, among other things, noted that:

  • In terms of the consumer price index (CPI) over the last 12 months, inflation in the UK is expected to rise from just under 4% in October to 4.5% in November, and to remain at that level through the winter.
  • CPI inflation is now expected to peak at about 5% in April next year – or at a level that is “materially higher” than had been expected in August. Inflation should be just above the 2% target in two years’ time and just below the target in three years’ time – at the end of the MPC’s forecast period.
  • The UK’s economy grew in 3Q21 by less than had been expected as recently as August. This was in part because of disruption to supply chains and in part because of softness in consumption. The MPC expects that the total size of the economy will recover to its 4Q19 (ie, pre-Covid) level in 1Q22.

As my colleague Charlie Morris pointed out in a recent edition of The Fleet Street Letter Wealth Builder, the UK’s gilt (government bond) market has also been signalling that the UK’s economy is headed for a slowdown or, indeed, a recession.

Two-year gilt yields versus 30-year gilt yields

Charlie noted (prior to the announcement of the MPC’s decision and the publication of the Monetary Policy Summary) that the key numbers to look at are the yields on the two-year and 30-year gilts (ie, UK government bonds)

Prices (and, therefore yields) in the gilts market are affected by a number of factors. One is the supply of gilts resulting from the government’s budget deficits. Another is the demand for gilts from banks, insurance companies and the Bank of England itself.

The yield on the two-year gilt is an indication of where investors think that interest rates could be at the end of that period. Conversely, the yield on the 30-year gilt tells you something about where inflation is headed over the long-term.

The gap between the two numbers has been narrowing. More precisely, the yield on the two-year gilt has been rising while the yield on the 30-year gilt has been tracking sideways.

At the time of writing, the gap is about the same as it was on 2 November, when Charlie was writing. The yield on two-year gilts has fallen to 0.48%, while the yield on 30-year gilts has dropped to 0.97%.

The crucial point is this: if the two-year yield rises above the 30-year yield, it is a very reliable sign that the UK is headed for a recession.

This was what happened after 1999-2000 and 2006-07, which were the last times that two-year yields were above 30-year yields for a reasonable period.

As Charlie says, a recession is not yet a certain outcome for the UK. However, he is not currently recommending investment in stocks that depend on economic growth in this country.

Meanwhile, it’s not just central bank interest rates and bond yields that matter. Inflation is important as well.

Interest rates versus inflation

Writing in Gold Stock Fortunes, another Southbank Investment Research publication, my colleague Nick Hubble argued in mid-September that investment markets are currently distorted by interest rates which are deeply negative in real terms.

In plain English, that means that interest rates (and bond yields for that matter) are a lot less than inflation.

“Hence the debt bloom and surging house prices. It makes more sense to borrow and buy than save because prices are rising faster than the cost of debt.”

Nick considered a crucial question:

“So, will central banks raise interest rates to rein in inflation? Or, more precisely, as inflation rises, will central banks raise rates faster than inflation increases? Will they raise interest rates above inflation?

I don’t think that’s possible given the amount of debt in our economies now. Central bankers want the inflation to bail out their friends at the treasuries of the world by making all that government debt worth less.

So, keep one eye on central banks and the other on inflation. If you go cross-eyed, expect a financial crisis as debt becomes unaffordable. If you get a lazy eye, buy gold, because central banks are behind the curve again, letting inflation run hot relative to their interest rates.”

The future prospects of the UK economy are uncertain, and will only become clearer as yields on two-year gilts move in relation to yields on 30-year gilts.

The prospects for gold are uncertain, and will only become clearer as interest rates move – one way or another – in relation to inflation.

Bitcoin versus the US dollar

However, certainty can be found in the crypto-currency markets.

As Southbank’s resident crypto-guru Sam Volkering noted in yesterday’s edition of Exponential Investor, the upgrade to bitcoin’s code will definitely be happening over this coming weekend.

If you want to know more about it, what you can do about it and the kinds of cryptos (ie, not just bitcoin) that could boom as a result, be sure to check out our broadcast here.

Sam has boldly predicted that the price of bitcoin will be higher than $70,000 by the end of Sunday night. Watch that space…

Until next time,

Andrew Hutchings
Contributor, Exponential Investor