Low and Slow

One of my favourite restaurants – “Pitt Cue Co” – opens its doors again next week after a bit of an absence.  I’m pretty excited: it’s now only 10 minutes from the office, it’s a bigger restaurant and they are taking bookings when before it was walk in only (queues frequently ran to over 2 hours at their previous place).

For those who haven’t been, Pitt Cue specializes in “low and slow” cooking which utilises low cooking temperatures, wood smoke and lots of time to transform often unusual cuts of meat into pure deliciousness.   Unfortunately, given a lot of it is based around red meat, whilst it’s undoubtedly good for the soul, the jury is out on whether it’s good for the body.

Just the right amount of heat

The low and slow technique is necessary where you have tough cuts of meat.  Cooking a pork shoulder quickly and at a high temperature means that the end result won’t be very good.

Economies have been prescribed a diet of low and slow future interest rate rises to try and get them out of a tough situation.

Quantitative easing (or central banks printing money to buy assets) has supported asset prices, and probably held off a deeper recession, but the move back to a more “normal” world without this support is looking increasingly indigestible.  This is particularly the case for interest rates. In the UK, the 50 year swap interest rate fell to 1.44% at the close last night – a new record.  Central bankers are rightly cautious – overdoing the speed of rate rises could be very unpalatable and tip economies back into recession.

Time for some looser trousers

Too much rich food is bad for the waistline and a low and slow path for interest rate rises is bad news for pension schemes that aren’t fully hedged.  For those schemes to actually benefit from being under-hedged rates need to rise higher and faster than that currently priced in. This is the opposite path that Mark Carney, the MPC and the market are now signalling.

Many schemes have been hoping for rises in interest rates to plug deficits.  However, the longer low rates persist, the more people’s perceptions adjust to lower rates meaning that if rates rise then people are likely to increase hedging at interest rates that would have thought were low a few years ago. This could mean (LCP make the point very well in this video) that pent up demand for gilts and swaps could limit the extent of any rate rises

The right strategy for the right cut

Just as you need to modify your cooking technique when you’re grilling a pork chop or slow cooking a shoulder, pension schemes need to entertain modifying their investment strategies to accommodate the possibility that rates could stay low for some time. Schemes should be looking at strategies that can perform well in low rate environments which may mean checking that they are comfortable with their hedging levels. Alternatively if Trustees have firm convictions that we have hit the lows in rates they should look to reflect this in their portfolio – either by unwinding some of their hedge, or through other strategies such as swaptions.


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