Over the last year, central banks have unshackled their previously ultra-low base rates to fight spiraling inflation. In doing so, they have ended years of cheap and easy funding conditions. Covered bond yields, for instance, have risen in tandem with bank base rates from lows of almost zero to the lofty highs of 3%.
But borrowers should not bank on these rates coming down any time soon, even as prospects of central bank pivots emerge. Despite the market pricing in and expecting rate cuts in the latter half of the year, recent experiences have shown that these predictions are just that: predictions.
Last week, the US central bank increased the Fed Funds rate by 25bp, taking it up to 5%-5.25%, and signaling that the long run of rate increases that started early last year has come to end. It did, however, leave the door open for further rises, if needed, as “part of a data dependent approach”.
But this did not stop the market from pricing in rates cut for later this year. According to CME’s FedWatch tool there is a 33% chance of a cut in July, rising to 66% in September and a near unanimous 92% in November.
Even then, hope of a rate cut in either July or September might be premature. Analysts at Nordea found that since the mid-1970s, it has taken the Fed on average five months to make its first move.
“A quick turnaround almost suggests either a rapid change in the outlook or a policy mistake of tightening too much,” added the analysts. “That said, rate cuts have also started even sooner several times in history.”
Across the Atlantic, the story is the same. Although, the European Central Bank are still on the hiking trail, rates are expected to slow sometime in the middle of the year.
The tightening between the inverted five- and 10-year points of the yield curve, down to minus 2bp from a peak of minus 25bp in late February, suggests that the market anticipates that rates are close to their peak.
But borrowers must beware that these are not certainties and remember that they are merely predictions. Late last year, there was a broadly held expectation that the Fed and ECB rates would peak sometime before the start of the second half of 2023.
Of course, a slowdown or a pause does not mean an end to the cycle. The Reserve Bank of Australia last week surprised the market with a 25bp rates increase, after it left rates unchanged at its April meeting “to provide additional time to assess the impact of the increase in interest rates to date and the economic outlook”.
The tone is similar in Washington DC and Frankfurt. Despite analysts anticipating a peak is near, chair Powell suggested that the Fed is "prepared to do more" while Lagarde did not entirely take the prospect of further hikes off the table.
There are still stumbling blocks on the horizon, so nothing is set in stone. For instance, the war in Ukraine continues to rumble on in the background, and although central banks seem to be winning the fight against inflation, the underlying data still leaves a lot to be desired. April’s 5.6% core eurozone inflation print, although down 10bp from the previous month, is still sticky and far above the ECB’s target.
And as the RBA showed last week, central banks are flexible. They will hike (or cut) if they believe it necessary.
But ultimately, no treasury funding head has a crystal ball — and of course any that did would probably move to the buyside anyway — and just like central banks, must make their decisions based upon the data they have before them.
If the primary market conditions presented before them look good, funding heads should seize the chance to print if they can. A central bank pivot is in the pipeline — but when it arrives is hard to see.