Filter insights on this page
Capabilities
Media type
Themes
Regions
In the quarterly Columbia Threadneedle Investments LDI Survey we poll investment bank trading desks on various topical questions around monetary policy and longer-term rate expectations. European markets reacted to the global phenomenon of peak rates and digested the possibilities interpreted in communications from members of the ECB.
The markets’ eyes were firmly on both the data and the members of the various central bank committees – watching for any intimation of timing or size of the anticipated monetary easing cycle. As higher base rates bite and growth figures disappoint expectations soar as to the rapidity of such a cutting cycle, particularly when inflation continues to fall and looks benign. In Europe, core inflation fell from 4.5% in September to 3.4% in December with no change to monetary policy over the quarter. Christine Lagarde – the President of the European Central Bank – has commented that actions will be driven by data and will not commit to a projected timeframe for rate cuts. In fact, even a debate on cuts is seen as premature. However recent meetings are viewed as dovish as the disinflationary trends were remarked upon whilst acknowledging weaker data releases. Wages remain a focus especially given their second-order effects, but the other data such as PMIs also matter.
Market Update – central bank rate
At the peak of the European base rate in this current cycle, uncertainty mounts as to the next phase and the impact it could have on longer dated yields. To that end we asked our bank counterparties for their view of where the base rate could be at the end of 2024, and the results are reflected in the below chart:
Chart 1: Bank respondents’ expectations of Bank Rate1
Source: Columbia Threadneedle Investments, as at 29 December 2023
There is a distinct lack of certainty as to how the Bank Rate will develop over the coming year with a significant spread between the highest and lowest estimates. However, our counterparties have coalesced around 2.5% or a drop of 1.5% from current levels. (Note that current market pricing has the ECB reaching 2.72% at the December meeting). Most of our respondents agree that once the rate cutting cycle has commenced, it will proceed apace, with action taken at every meeting – therefore the disagreement lies with when exactly the ECB could start the monetary tightening cycle. Where growth is merely stagnant then a gentler beginning to tightening could be anticipated; yet if the growth picture deteriorates quickly then rapid action is required to bolster the economy. However, all bets are off if inflation reverses its downward trend, perhaps as a result of persistent food or labour market inflationary impacts, as that will make it more challenging for the ECB to fly in the face of these pressures. In addition, the sensitive geopolitical situation could weigh upon all these factors perhaps increasing the level of uncertainty seen in our counterparties’ responses.
For pension scheme investors, the base rate is only part of the picture, ultimately how this feeds through into longer dated yields impacts the discounting of liabilities. Therefore, we also challenged our bank counterparties to predict where the 30-year swap yield would be in one year’s time; shown in the below chart:
Chart 2: 30-year swap yield with predicted future movements
Source: Columbia Threadneedle Investments; Bloomberg
Again, there is a wide range of expected outcomes for the 30-year swap yield for the end of 2024. Partly this must be ascribed to the uncertainty around the Base Rate, but our counterparties also cite the impact of a heavy issuance schedule from EU governments this year and the unknown impact of Quantitative Tightening. They would also anticipate term premia reigniting helped by those two factors. For those who predict a rally in yields; they note the assumed ongoing demand for duration from Dutch Pension Reform; and that Euro-area insurers currently have a large duration gap which if filled would exert considerable downward pressure on long-term yields. In a risk-off environment with geopolitical risk rearing its head, global fixed income allocations could rise giving further support.
Market Outlook
The Columbia Threadneedle Investments LDI Survey also asks investment bank derivatives trading desks for their opinions on the likely direction of key rates for pension scheme liability hedging. The aim is to get information from those closest to the market to aid trustees in their decision-making.
The results are shown below as the number of those predicting a rise less those predicting a fall, as a percentage of the number of responses. The larger the balance, the more responses predict a rise. The more negative the balance, the more responses predict a fall.
Chart 3: Change in swap rates over the next quarter.
Source: Columbia Threadneedle Investments. As at 29 December 2023
In the previous quarter our counterparties were evenly split between a rise or a fall in 30-year swap yields and had low conviction for a fall in both real and inflation levels. As it happened, all three metrics fell quite substantially as markets digested the Dutch Pension Reform news and looked forward to the start of the monetary easing cycle.
Our counterparties predict a fall in all three metrics for the first quarter of 2024. Again, there are differing opinions resulting in a low conviction prediction, in particular for swap yields. The main area of concern driving the expected decreases is around the stuttering growth in the Eurozone and in particular the weak performance of the German economy given its reliance on exports in a diminished global demand environment. Real GDP contracted in the third quarter of 2023 and forecasts currently predict a further contraction in the first half of 2024. As discussed earlier, the ECB will be keeping a close eye on data, including PMIs and if these continue to weaken, could embark on rate cuts earlier than anticipated. This in turn would result in yield compression across the board. Countering these arguments is the reduced interest seen in government bond auctions in December given the market rally and lower overall yields – which resulted in significant new issue premiums required to drive demand. Supply is likely to be high in the first quarter as issuers tend to avoid election and political risks due later in the year.
