Key points

  • It looks more likely now that US interest rates have peaked.
  • We expect UK interest rates to follow suit and for inexpensive, economically sensitive companies to continue to benefit.

Predicting the precise time when sentiment turns is fraught with difficulty, but there is a good chance that this happened with the release of October’s US inflation data. After many months of rising bond yields and falling stock valuations, US consumer-price data came in marginally lower than expected; the S&P 500 Index rallied 2%, and US Treasury yields dropped sharply.1 The gains in the UK’s FTSE 100 Index were lighter but the composition was more interesting. Shares likely to benefit from falling rates and improved economic activity were shaken from the slumber of the last couple of years. These included property companies, housebuilders, industrials and financials. UK consumer-price inflation data continued the trend, dropping from 6.7% in September to 4.6% in October,2 again undershooting economists’ expectations.

The change in mood was certainly welcome to us as managers of a UK equity income strategy. For several months we have been using our clients’ money to buy these attractively valued shares, waiting for the moment when others might also spot these potentially profitable opportunities and join us.

The gloom of the last two years has been broadcast at high volume. War, higher inflation leading to higher rates, falling asset prices and the constant threat of a recession which has never quite arrived have been the constant story for the last few years. However, all difficult times end eventually and when they do, investors look forward and risk appetites increase. The point of change can be when some of the most outsized gains in the stock market can be made. Conversely, these are vicious rotations for those with entrenched bearish positioning. 

To understand why inflation is dropping, it is worth considering its origin. For this, I offer you my apologies in advance as I ask you to return in your mind to the time of the pandemic, since it is here where the origins of this inflation began.

Two distinct economic events occurred during the pandemic, and they both caused inflation: there was the impact of new money created through government largesse, and the impact on the availability of goods owing to disruption to supply chains. The effects of both may be receding, but while the first may take some years to work off, the second is rather more likely to be transient. The receding effects of both are likely to mean that interest rates have peaked, and a global recession may be avoided.

First, let’s consider the impact of new money. Governments across the developed world handed over money to anyone who seemed worthy, with few strings attached. In the UK, we had the furlough scheme and small business loans, most of which will never be repaid, and a large proportion of which were acquired fraudulently. In the US, money was deposited directly into the accounts of every US citizen; even US citizens living in the UK received a gift from President Donald Trump to add to their furlough money. Deposits sat dormant in bank accounts during lockdowns as there were few things interesting to spend upon. However, as soon as lockdown finished, inflation jumped. Lots of new money but no new goods and services is a recipe for rising prices. Only when all the new deposits created have stopped chasing the limited supply of goods and services should inflation caused through this effect cease.

Secondly, the pandemic caused disruption to supply chains which was also inflationary. Fewer people were able to work in factories and offices, ports were understaffed, and travel of goods and people were restricted. In an intensely specialised world, with parts for finished goods coming from many different countries, it would only take one or two bottlenecks to cause chaos, which duly ensued. The natural response to worries around supply was hoarding. While consumers hoarded toilet rolls, industrial companies did the same with everything they thought might conceivably be useful: oil, paper, building materials, chemicals and semiconductors. The consequence was shortages of just about everything and a resulting spike in prices.

Now for the good news: supply chains are rapidly normalising. A range of early cyclical companies have experienced unprecedented reductions in demand – chemicals companies and semiconductors have never had such a dearth in new orders. We differ from mainstream thought sharply here. This is not a sign of recession, but rather a normalisation process as customers work off their pandemic inventories. We believe the removal of cost and excess stock from supply chains should turn out to be very deflationary, and economically stimulative.

Deposits in the banking system still remain as the result of government excesses, which may mean that rates do not return to their pre-pandemic lows. However, it looks more likely now that US interest rates have peaked. The bond market agrees with us, with US 10-year yields dropping sharply following the release of the US inflation data. We would expect UK rates to follow, and for inexpensive, economically sensitive companies held in our UK Equity Income strategy to continue to benefit.


  1. Financial Times as at 14/11/2023
  2. Office of National Statistics, CPI.

Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.


Tim Lucas

Tim Lucas

Portfolio manager, UK Equities team


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