Back to the races

Henry Adams

Chief Product Officer
Wednesday, Apr, 24, 2024

It has livened up out there! Despite continued geopolitical uncertainty and the potential for further escalation, markets are powering ahead. Risk remains on, stocks gaining momentum (upwards) whilst the chances of interest rate cuts in most major markets we cover continue to be delayed, and trimmed.


Rising oil prices are continuing to cause headwinds, putting pressure on prices far and wide. Whilst we are off the highs of the year in early April, when looking back to the beginning of 2024 we are up just over 14%. This should not be ignored.
This, along with potential and real disruptions to supply  and shipping costs creeping up, is making the already undesirable role of the central banker yet more challenging. The Baltic Dry Index, a popular measure to understand the price to transport goods around the world, whilst lower than where we began the year, is certainly on the upward march since the beginning of April, at a rather staggering 12% up. Much has been said regarding de-globalisation and less reliance on imports. The trouble is twofold. One cannot simply replace the means of production overnight. It is also inflationary as this requires capital spend, and preferably not from fresh debt. Nothing comes for free. In short, Q2 kicks off with a resurgence in inflation despite rates remaining elevated, forcing delays to easing promised just a short while ago.


As we drive towards the end of the month, Q1 earnings season is in full swing. The early barometer of bank earnings has pretty much concluded. So…how did we do? A mixed bag as always, but certain themes have been observed. Those with more active trading desks in fixed income, equities, and commodities have done well, driven by both some volatility as well as the aforementioned upward momentum. This time last year, investors were struggling to see and exploit direction, markets effectively flatlining. This year though, one must keep an eye on the potential for outsized event risk. Those financial institutions more heavily focussed on corporate and retail clients saw pressure on net interest margins, effectively the difference between where they borrow and lend. The driver? Upward price pressure on keeping and growing their depositor base as competition heats up and clients rightly demand and are more active in placing liquidity at fairer levels. Over the coming fortnight we will see how the rest of the economy looks, as a plethora of non-financial companies start reporting. One interesting early gauge was the British Retail Consortium’s survey focussed on pricing in the UK. Here, 47% of firms believed they could and would pass on higher prices to their end customers whilst less than 5% felt they could not. Significant also as this was the highest reading since the highs of the transitioning COVID world of mid-2021.


The first quarter saw record levels of issuance despite what at the time looked like cheaper money to come. Many looked to square off the bulk of their borrowing needs for the year, which may have looked early given the inverting yield curve. This inversion has reversed and those that tapped into what felt like unlimited liquidity have done well. Credit spreads (or the premium over the risk-free rate) have widened from extremely tight levels and for the first time this year we saw markets effectively shut for part of the month amid the (hopefully brief) escalation that brought Iran into the Israel/Palestine/Hamas conflict, proxies aside. Rating agencies have been following closely, with S&P following Moody’s in cutting Israel’s credit rating last Thursday from AA- to A+, outlook negative.
In the UK we had a reminder of when privatisation goes bad, with Thames Water continuing to dominate headlines. Nationalisation of some form seems almost inevitable following the firm borrowing excessively whilst paying out dividends to shareholders, until the music stopped. The spend to fix leaks and spills has increased £1.1bn despite not having the backing of owners who do not support the issuance of new equity. Whilst not great, what is far worse is the reported 40% rise in annual bills for those supplied by them. Sadly one cannot just turn the taps off, and households and businesses alike will have to factor in yet higher outgoings without an ability to substitute. This has naturally caused significant deterioration in bond prices for the water company that has now leaked to others, making the sector one of the worst performers thus far this year.


Expectation here unlike elsewhere has not shifted, with rate-setting members continuing to cite that despite oil prices and other important inflationary measures, the EU still needs to see rate relief in the next meeting of June 6th. The market believes them, with a modest 0.25% cut currently the most likely outcome of the ECBs next meet. Interestingly, CNBC managed to pin down 12 members of the ECB’s Governing Council last week at the International Monetary Fund’s (IMF) Spring meet. For once, in short, it feels like they are all singing from the same hymn sheet. We are told unequivocally to be ready for the 0.25% cut. There is also concern and attention being drawn to the Middle East and the non-zero chance of contagion and spillover effects. With inflation coming in at 2.4% (CPI) for the month of March, their move seems both prudent and on time. There has been much talk about whether a 2% target is still appropriate (for what it’s worth, I do not) and the cost of squeezing out the final rounding error of price rises above the magical number which could crash the economy for the sake of a statistic. The main potential drawback? A weakening Euro might create an additional source of inflation if the Eurozone were a net importer. According to the latest statistics though, the pact was a net exporter to the tune of EUR 22bn, thus making them yet more competitive as their currency becomes cheaper as the US remains the main importer of their goods and services (at 14% net). This also represents a reversal of fortunes from where the Eurozone was net importing. For now we have a total of 0.75% of cuts expected, although beware the reversal of inversion seen elsewhere.


Inflation has eased to 3.2%, which at any other point would be an overshoot. Having peaked at 11% in October 2022, it’s starting to look incredibly sensible. In terms of how this leaves rates, well…we are currently priced to see just over two cuts, the first of which is likely to take place in August. We are likely in an election year (January 2025 is unlikely), with the polls expected to open in November. The message to voters and their pockets might be one of relief, finally. Although, it is also worth noting that the last several months have seen real wages increase, according to official figures. Not sure it still correctly reflects an ordinary household’s basket of goods though, with rents rising at record levels, reaching 9.2% (annually, March) for England and Wales. Last week’s IMF meeting was informative not just for CNBC. Their advice to Rishi & Co was to take a considerably tougher stance on debt. Cuts to national insurance seem to counter such thinking. It feels like a show we have seen before, with the always helpful IMF also sharing that the UK is expected to show the second slowest growth rates of the G-7. With the expected outcome being the booting out of the incumbent, perhaps fiscal prudence is lower down on the list of the current government. This may well mean bigger shocks to come should/when Labour come to power as the polls predict (with some margin).


The UK and US have shared much. Sadly, again thanks to the IMF, ballooning debt and spending beyond one’s means is, from an economic standpoint, at the top of that list. The magnitude of new issuance is mind-boggling. We have completed Q1 and the big release from the U.S. Department of the Treasury has been published. More than $750 billion in treasuries issued, net! Total borrowing stands at just shy of $35 trillion. More than two percent added in a single quarter? This seems far from sustainable. Inflation is not out of control at 3.5% (March CPI, 12 month year-on-year) but did increase, thereby catching those betting on more cuts sooner off-guard. Employment is still holding in and wages are rising despite rates remaining elevated for some time. For now, nothing major has gone pop. In fact, the economy appears to be doing so well that there are those who now see terminal rates a full 1.00% above where we find ourselves today. As much as I am an optimist, this does seem overly enthusiastic, particularly as the consumer is running out of savings in a consumer-led economy. It is also noteworthy that not insignificant parts of the property sector appear rather fragile. Looking more broadly across credit and its deterioration, there are reasons to be wary, as well as question book versus market value. One can, at the very least, expect more debt ceiling discussions and blackmailing, which no matter what warrants attention and requires planning in a world where a great deal of liquidity parked in US government product is assuming you’ll be paid on the day. 
No matter what, almost all cuts have been taken off the table, with just 0.40% left on the slate. It is easy to forget the magnitude of the shift. As a reminder, we kicked the year off with 1.60% worth of easing projected before 2025. Recent Fedspeak including from Chair Jerome Powell has shifted in tone. The next meeting of 1 May is expected to reflect the shifting in odds of not just higher for longer, but higher, full stop.

So what?

As earnings season kicks off in earnest we will have far more visibility on the state of the economy, business, and the consumer in a few short weeks. Whilst banks have done well, it has not come without compression to important parts of their balance sheets. Risk, despite some conflict-related wobbles, has held up rather well whilst curves across the globe have generally flattened, with a few exceptions. For now, in the core markets we cover, we are yet to see a post-COVID cut despite all the rhetoric and ballooning debt piles that at some point will be unsustainable if not reigned in. The risk does feel closer to the downside the higher we go. Thus, given the reversal of much of the inversion, for now, as a (relatively) reformed interest rate trader I would be looking to term some of my liquidity up to take advantage of rates that will not remain up here forever. Given the opportunity cost with levels where they are is minimal, unless one believes the next moves are all up, it feels like as good a timing as ever to apportion some funds to longer tenors, locking in return.

Views expressed are the author’s own and do not represent the views of TreasurySpring or its affiliates!

*TreasurySpring’s blogs and commentaries are provided for general information purposes only, and do not constitute legal, investment or other advice.


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