Jeremy's Blog 12th January 2024: The Outlook for Interest Rates
This article by Jeremy Moody first appeared in the CAAV e-Briefing of 11th January 2024
Recent weeks have seen a mood that interest rates may be on the way down. However, UK 10 year gilts are nudging back up to 4 per cent and there seems reason for rates to remain higher for longer and also be more volatile.
The strange period was the 15 years of unprecedented ultra-low interest rates from 2008 to 2023, not the last few months in which we have returned to a world of significant interest rates. That holiday from reality means that many have forgotten or have never experienced such normality. As Tony Despirito, the Chief Investment Officer of the global investment fund, BlackRock, has said:
“If you look back at history, it’s the post [financial crisis] period that is the anomaly … we’re in market that either favours people with a lot of long term experience or at least students of history of the market.” (Financial Times, 14th November 2023)
The talk of rates falling is set in the context of their current policy use to tackle inflation with the supposition that, if inflation returns to target, rates too can fall away. That forgets the other roles for interest rates. They represent the price of time, the cost at which borrowers can persuade savers to defer their spending into the future and allow borrowers to spend now.
Within that is the enormous appetite of governments, in the west and in emerging markets, to spend more than they can raise in tax with no apparent prospect of returning to balance. A former Governor of the Bank of England observed that our public finances rely on the kindness of strangers. More sharply and echoing a lesson of the Truss government, Sir Robert Stheeman, the outgoing head of the UK Debt Management Office warned last week:
“In a world where we have debt to sell, policy making cannot be divorced from the reality of the debt market.” (City AM, 4th January 2024)
As in 1976 and 2022, that reality may force difficult decisions on policy, spending and taxation.
The concern in bond markets is illustrated by Jim Cielinski, global head of fixed income at Janus Henderson, seeing deficits in most western countries as:
“out of control and the real story is that there is no mechanism for bringing them under control”. (Financial Times, 9th January, 2024)
requiring record levels of bond sales, only exceeded in the Covid year. The scale of that was put dramatically by Robert Tipp, head of global bonds at PGIM Fixed Income:
“We are in a truly unmoored environment for government debt compared with previous centuries.” (ibid)
Bond sales at current interest rates have gone well in last few days buying ahead of expected falls. However, markets are becoming nervous about this year’s global wave of elections. Politicians from the USA to India and the UK may be tempted to offer pledges that can only be funded by the debt markets at the price they set. As the UK saw in September 2022, that can lead to sharp increases in rates as markets move from being buyers to being sellers with that volatility being hard to contain. Such experience led James Carville, a political adviser to Bill Clinton, to muse about reincarnation:
“I would like to come back as the bond market. You can intimidate everybody.”
Managing the consequences in a democracy without economic growth and weakening demography is one of the major political challenges of our time.
With interest rates also being a marker of risk, this climate would equally put valuers on their mettle in appraising asset values.