Your weekly economic update from the team at FXD Capital
For well over a year, speculation about negative interest rates has never strayed far from the front of mind. For some, it seemed only a matter of time before the Bank of England and Federal Reserve followed precedents set by the eurozone, Nordic countries, Switzerland, and Japan to lower base rates to negative territory.
Now, as we head into May 2021, negative interest rates are old news, and momentum is gathering for rate rises.
A little under three months ago in the UK, the forward OIS (overnight index swap) curve was range-bound between 0.1 and -0.1 for 36 months. It was essentially predicting a continuation of the 0.1% base rate status quo for the next three years.
As a proxy to central bank rates, OIS is as close as you can get: an overnight tenor on the floating leg (albeit secured via private collateral, instead of a central bank guarantee) as a proxy to the BoE’s deposit facility.
The OIS curve now has a higher magnitude of steepness, with the 36-month tenor sitting at 0.5%, the vanguard base rate benchmark we have known so well since 2009. The curve is pricing in 15bps of rate rises next year and 40bps by the end of 2023.
The first steps towards any changes are likely to be a taping of quantitative easing, with the BoE slowing down the pace of its bond-buying programme. In upcoming BoE meetings, watch out for sentiment regarding this.
The pace of expected rate rises is pedestrian, but the context of the narrative shift from negative rates to a tapering of QE over three months is what’s more important. The spillover of the change will be that demand for money in the financial system will gradually creep up, manifesting in heightened competition for deposits. The gambit any bank runs is pricing short term deposits too far above par for the course (in this case, the BoE overnight rate); movements in the OIS curve suggest that appetite is growing in this regard.
A glance at other central bank rates shows Eurodollar futures markets pointing towards a late 2022 increase for US rates. September 2022 futures offer an implied rate of 0.215%, which gives indicative guidance towards a 0.25% Fed Funds benchmark by the end of that year. EONIA rates in Europe are flat and don’t indicate a change from current conditions over the next couple of years.
ONS data on Thursday showed that UK household net worth had risen to £11.4 trillion in 2020, an equivalent of £172,000 per person. An 8.5% increase in house prices and a strong year of stock market performance were two critical factors behind the growth. For context, household net worth is 4x higher than in 1995, but on a cash basis (i.e. liquidatable financial assets) only 2.5x higher – demonstrating the compounding power of housing stock and the UK’s continual obsession with it.
It seems that every other week I write about economic growth predictions, and this week is going to be another one of them. UK growth predictions continue to see upward revisions. Consensus Economics (an aggregator of forecasts) shows a 5.4% average GDP growth prediction for 2021, up from 4.2% in February. Some of the more optimistic forecasts are providing indications in the 7% range.
In a press conference following the Federal Reserve’s monthly meeting, Fed chair Powell gave some cautious context to the recent euphoria surrounding the US economy’s Covid bounceback. He signalled that the Fed is still far away from withdrawing support to its asset purchase programme: “We’ve had one great jobs report, it’s not enough”. One swallow doesn’t make a summer and all that.
As expected, the Federal Open Market Committee upgraded its view on economic conditions and kept rates the same and debt purchases at $120 billion per month.
The US labour market is 8.4 million jobs short of its pre-Covid state, indicating that the recovery still has wiggle room to account for surplus labour supply before it gets to the point of overheating. Treasury yields now appear to be ranging within new bounds, following their shift earlier in the year. 10-year USTs seem to be settling between 1.6 and 1.7%
GDP advanced to an annualised rate of 6.4% on Thursday, topping consensus estimates of 6.1%. Economic output increased 1.6% in Q1.
Data later today is likely to confirm the eurozone’s double-dip recession in Q1 2021. Expectations are for a 0.5% contraction, following a 0.7% fall in the final months of 2020.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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