This week has seen bonds rallying further on expectations that we are approaching a turning point in interest rates as we move into the New Year.
The tone in recent speeches from both Federal Reserve and European Central Bank members has led to markets pricing in a significant number of rate cuts in 2024, far from the ‘higher for longer’ narrative that has been the backdrop for markets for most of the year. Even the Bank of Japan, where rates are still below zero, has been hinting at a shift in policy, though in this case, it would be in hiking policy rates.
The narrative on interest rate cuts continues to gain momentum, particularly in the US and eurozone, where the language from central bankers has been much more nuanced on the outlook for rates as we move into 2024. While the Bank of England under Andrew Bailey continues to push the ‘higher for longer’ messaging, the more dramatic falls in inflation in the eurozone and US has led to a shift in tone, subtle in some cases, and in others more overt. With the Federal Reserve in ‘blackout’ ahead of their meeting next week, the speech from Chair Jay Powell late last Friday was the final signal for investors ahead of this brief quiet period.
The Bank of Japan saw speeches from Governor Kazuo Ueda and Deputy Governor Ryozo Himono. Both were interpreted as subtle hints at policy shifts in the near future. Ueda noted that monetary policy management would “become even more challenging from the year end and heading into next year” while Himono spoke on the impact of negative interest rates, pointing out that a wide range of households would benefit from interest income if rates were positive, saying “a wide range of households and firms would benefit from the virtuous circle between wages and prices”. These comments were interpreted as laying the ground for a potential policy shift later this month, and the Yen weakened notably as a result. Japan has had negative interest rates since 2016 is the last bastion of the zero rates and quantitative easing era in developed markets. Any normalisation of policy will impact liquidity globally as the ‘carry trade’ of borrowing at ultra cheap rates in Japan and investing elsewhere becomes less rewarding.
Next week sees meetings from the Fed, ECB and Bank of England – no change is expected in policy but with the market mood shifting so decisively in recent weeks towards rates being cut, any pushback from the central banks on this assumption has the potential to upset the festive mood. Likewise, with the prospect of policy shift from the Bank of Japan becoming more likely, their meeting on 19 December has now become a potential turning point in bringing to an endthe era of ultra loose monetary policy. The BoJ tends to move slowly but has sprung the odd surprise in the past and an end to Yield Curve Control and an indication that rate hikes are on the horizon should not be ruled out. We watch with interest given the recent rally in developed markets has been predicted on central banks being on the cusp of loosening policy, but as we have seen plenty of times over the past couple of years, financial markets have collectively been incorrect in their assumptions on the path of policy on the way up, so having too much confidence of the future path on the way down may well prove equally wrong.
Have a good weekend,
Regards,
Anthony.
