Investors have scaled back their expectations of global interest rate rises in the aftermath of banking sector turmoil, with market indicators suggesting that the period of rapid increases has come to an abrupt end.
The pricing of derivatives products, such as interest rate swaps, indicates investors believe many of world’s major central banks will not raise rates further and, in some cases, will begin to impose cuts before the end of the year.
“Global interest rates are near a peak,” said Mark Zandi, chief economist at Moody’s Analytics. “The suddenly fragile global banking system is putting pressure on central banks to end their rate hikes sooner rather than later.”
Swaps rates now suggest the US Federal Reserve, Bank of Japan and seven other major central banks are all now expected to keep rates on hold at their next meetings. Markets are split on whether the Bank of England and the European Central Bank will raise rates in May, after pricing in a high probability of a rise at the start of March.
‘We’ve had one of the most aggressive rate hiking cycles in decades, followed by banking turmoil and now peak rates are firmly on the horizon,” said Susannah Streeter, senior investment analyst at asset manager Hargreaves Lansdown.
The reappraisal comes after one of the sharpest tightening cycles in recent history. Over the past six months, 18 major central banks have increased rates by a total of 16.45 percentage points.
Just a fortnight ago, the peak in global interest rates had looked further away.
In early March, investors had expected the federal funds rate target range to rise as high as between 5.5 per cent and 5.75 per cent by December, from its current range of 4.75 per cent to 5 per cent. The shift in derivatives pricing signals markets now expect the range to be around 4 per cent by then.
At the start of this month, investors had expected the European Central Bank’s deposit rate to hit 4 per cent towards the end of the year – up from its current level of 3 per cent. They now anticipate a deposit rate of 3 per cent by then. The expectation for the Bank of England’s bank rate towards the end of the year has gone from around 4.75 per cent at the beginning of March to around 4.25 per cent as of Monday.
“The major central banks, including the Fed and the ECB, should make a joint statement that any further rate hike is off the table at least until stability has returned to the financial markets,” said Erik Nielsen, chief economics adviser at UniCredit Bank.
Last week, the Fed, Bank of England and Norway’s central bank all raised rates by a quarter percentage point. The Swiss National Bank went for a half-point rise despite the rescue-takeover of Credit Suisse by its rival UBS, and the ECB did the same the previous week.
However, policymakers in most of those banks have signalled that a further rise in borrowing costs depends on turmoil in the banking system abating.
“You can think of [the turmoil] as being the equivalent of a rate hike or perhaps more than that,” said Fed chair Jay Powell last Wednesday, signalling the panic could do rate-setters’ job for them.
“Because of stressful conditions, banks become less willing to lend and they’re going to lend often by increasing the interest rate,” said Costas Milas, a professor at Liverpool university.
UBS forecasts that, by the end of 2023, more than half of the 32 central banks it tracks will have lowered their policy rates. Another seven will have left them unchanged.
However, some economists remain concerned high inflation will force lenders to keep on raising rates.
Zandi said signs inflation will prove persistent could mean central banks would “sacrifice their economies to get inflation back to their targets”.
Inflation figures for the US and eurozone are due out on Friday.
Some rate-setters in Latin America and eastern Europe have kept interest rates on hold for months.
“Central banks in emerging markets were some of the first to react to rising inflation and hike rates, and still may be the first to embark on a rate cutting cycle,” said Streeter.
The market for interest rate swaps is one of the world’s largest derivatives markets. The gross value of outstanding interest rate derivatives rose significantly over the first half of 2022 in response to central banks’ rate rises, according to Bank for International Settlements data.