US and UK rate rises: done but not yet coming down

Federal Reserve

Once again, the Federal Reserve (Fed) maintained policy rate at 5.25% - 5.50% in line with market expectations. However, the messaging and interpretation by the market was far more interesting than any rate move would have delivered.

Governor Powell gave a clear signal that the Fed were now on hold, he reiterated that data had been robust and that getting inflation back to the 2% target was key, but at the same time downplayed the importance of the ‘dot plot’ forecasts and gave the market confidence that the bar is high to see a final hike in December. In the same breath though, he also emphasised that it was far too early to discuss interest rate cuts and that the committee would be firmly focused on the employment reports in coming months to determine the lagged effects of previous policy rate decisions.

As a result, the US treasury market surged lower in yield with 2-year, 5-year and 10-year yields falling by 14, 20 and 20 basis points respectively as the market priced out any possibility of future hikes. What was even more interesting was that 30-year yields kept pace in the rally as the previous day’s announcement that there would be a smaller increase in long-dated issuance than the market expected, removing some concerns around the ballooning US debt profile.

In general we have been positioned long duration, as we are of the opinion that we have seen the peak in interest rates or are close to it. The resultant market rally has been beneficial for performance. We have also favoured dollar-based markets recently as US treasuries (nominal and real yields) and Australian government bonds have looked very attractive versus their global peers. The market reaction to the Fed decision has backed this stance.

Bank of England

At the Bank of England’s (BoE) meeting, the committee voted to keep rates on hold at 5.25%, by six votes to three; the three dissenting members all voted for an additional increase in rates of 0.25%. Overall, this outcome was very much in line with market expectations. As was the case at the previous meeting, the BoE maintained its narrative that the decision had been finely balanced between holding rates at 5.25% or hiking by 0.25% to 5.50%. After all the Consumer Price Index inflation rate remains stubbornly high at 6.7%, and while expected to fall, it is not expected to return to the BoE’s 2% target until late 2025. However, recent economic data releases have been weakening and also disappointing versus the market expectations. Furthermore, as the BoE themselves have stated in the past, there is still a considerable amount of tightening yet to feed through into the real economy, due to the slow transmission mechanism and pass through of previous rate hikes. In this respect further hikes seem unlikely.

The November meeting was also a monetary policy report month, providing the market with an update on the BoE’s projections for the economy. In reality, little has changed since August; Projections for economic growth were lowered throughout the forecast period, while inflation forecasts were cut in the near term but raised in the medium term. Based on the market implied path for rates, inflation is set to be at or around target in 2025 and 2026. Unemployment is expected to rise throughout the period to peak at around 5.10%. So all in all, little change here. The market reaction to the committee meeting was largely muted, with the tone for bond markets having been set by the Fed on Wednesday.

Ultimately, where Fed Chairman Powell led, BoE Governor Bailey has followed. Central banks might be talking a ‘higher for longer’ narrative with the possibility of further hikes; but in reality they are largely done. Central banks are understandably emphasising that it is still too early to be thinking of cuts, fearing that to do so too early would see bond yields fall, and financial conditions loosen, undoing some of the work from previous hikes. However financial markets are not; they are moving on from base rate hikes to focus on when and how far base rates need to fall already. How this plays out will be central to the performance of bond markets next year.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.