Traders Start to Doubt the U.K. Rate Hikes They Just Predicted
U.K. traders are starting to back-pedal after piling on bets that the Bank of England will raise rates this year.
While wagers for increases over the next year have been ramped up to more than 100 basis points, concerns over that pace of tightening are now surfacing in various corners of the market. Pound traders have not pushed the currency higher and interest-rate swaps signal any tightening may be soon followed by easing.
All these are signs of fear that rate hikes could be a mistake that squeezes consumers, amid a heady mix of threats to the Brexit deal, surging Covid cases and sky-high energy prices. This backdrop sets the stage for November’s rate decision -- one that Chief Economist Huw Pill called “finely balanced.”
“Markets are pricing that the BOE will not be able to raise rates a lot, signaling that the forthcoming hikes will cool inflation and also the economy,” said Bob Stoutjesdik, a fund manager at Robeco Institutional Asset Management. “You can label that perhaps as a policy error being priced.”
Here’s a look at some of the ways investors are casting doubt over how high rates could go:
Sterling has broken its link with bond yields, holding below $1.40 for a fourth month even as two-year rates surged to the highest since May 2019. Higher rates have supported the currency in the past, yet investors are now fumbling over what it all means for the pound.
Money managers at Jupiter Asset Management and Aberdeen Asset Management turned neutral on sterling in recent days, following similar moves by Amundi SA and William Blair Investment Management. Meanwhile, strategists surveyed by Bloomberg have downgraded their median year-end forecast to $1.37, down from as high as $1.43 four months ago.
The BOE will likely defy investors’ expectations of a sudden interest-rate increase next month because it rarely shifts policy in such dramatic fashion, according to three former senior officials.
Any indication of less immediate tightening and a more progressive rate-hike path would shore up the pound, according to Peter Chatwell, head of multi-asset strategy at Mizuho International Plc.
“It would be an effective use of forward guidance, like any credible developed-market central bank would use,” Chatwell wrote.
Up, Then Down
The market’s proxy for the future level of BOE interest rates -- the sterling overnight index swaps curve -- is also casting doubt over the longevity of any policy tightening. It’s signaling that the key rate will peak at around 1.15% in 18 months, only to fall back toward 1% by the end of 2024. That has resulted in an inverted curve, which is interpreted by some as a sign of an impending economic slump.
Similar doubts are emerging in short-sterling contracts which are tied to three-month funding costs. The spread between expiries in two- to three-years’ time -- an indicator of the direction interest rates may take -- has inverted by the most since the 2008 global financial crisis. That’s another indication that traders expect any tightening to be followed quickly by easing again.
Forward swaps -- which are used by pension funds, insurers and companies to manage future liabilities -- offer another signal of markets pricing an eventual u-turn in policy. The two-year rate exceeds the three-year equivalent by the most since 2008. Back then, markets and policy makers were grappling with the fallout of the global financial crisis, resulting in rapid and sometimes inexplicable moves.
This Week/Next Week
- The ECB policy outcome on Thursday dominates the agenda with President Christine Lagarde expected to comment on rate hike bets of as much as 10 basis points by the end of next year
- European government bond supply of 23 billion euros is expected from Germany, Italy and the Netherlands according to Citigroup Inc., while the EU will sell a 7-year bond for up to 2.5 billion euros; the U.K. will sell up to 2.75 billion pounds of five-year notes
- On the data front, the highlights are euro area and German inflation numbers for October and third quarter growth figures; Germany also publishes the October Ifo survey; U.K. Chancellor Rishi Sunak unveils the budget on Wednesday
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