Shane O'Neill, Head of Interest Rate Trading
A busy month for interest rate markets as we heard from all three major central banks – though the direction of travel for each bank appears to be the same, they are each getting there in very different ways. On the back of these meetings, we saw large changes in yields, though price action this month has been focussed on longer dated tenors.
In the US we saw the Fed pause their hiking cycle for only the second meeting since they began moving rates higher in March 2022. Though they paused, the messaging around the decision was clearly hawkish. Powell sees another hike this year as likely due to inflation remaining elevated and the economy proving sturdier than previously forecast. In addition to the telegraphed hike, the Fed dot plot revised yields higher in 2024. In June they had seen rates dropping to 4.5% next year but now they expect rates to remain above 5% - again, thanks to stickier inflation and a robust economy.
The market reaction to the presser was a moderate repricing in rates. The peak rate remained virtually unchanged as markets predict another hike this year as unlikely – less than 50/50 chance. Into next year we saw rates move higher with the terminal rate by the end of 2024 coming in at 4.6% versus 4.4% before the meeting – though importantly still below the Fed’s expectations of 5%+. As we have pointed out previously, the cuts priced in feel too aggressive and though some of the benefit to hedgers has been removed, there is still a downward sloping curve which helps pricing look more attractive.
The bigger moves in the US came further out the curve, the increased likelihood of a soft landing coupled with expectations of stickier inflation saw investors off load long dated treasuries which now offer less attractive returns for the associated risk. All benchmark treasury rates jumped to decade long highs on the back of the Fed, with 10y yields passing 4.6%, their highest level since 2007.
In Europe we saw the ECB hike rates by 25bps to 4% and drive home a message that rates will be staying at these elevated levels for some time. Lagarde wouldn’t say this was the peak but what she is clear on is cuts: “not even a word we have pronounced.” Despite this, and similar to the US, markets are still pricing in cuts for next year, almost 75bps in total. And, again similar to the US, presenting an interesting opportunity to fixed rate payers who don’t quite believe the markets expectations of falling inflation and rate cuts.
The BoE meeting in the UK was taken as the least successful of the three – the MPC paused rate hikes by a narrow margin (5-4) leaving markets concerned that Bailey and co. are neither solving the inflation issue nor saving the economy from a downturn. The stagflation worries were reflected in the pound which fell to its lowest levels against the dollar since the start of the year and some 7% off the YTD highs seen in July. Recent GDP data showed the economy is doing better than feared (and growing faster post-Covid than France and Germany) but core inflation remaining over 6% will keep investors on edge. The next inflation release in mid-October will be watched very closely.
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