Tag: Interest Rates

Interest Rate Overview: Eurozone, United States, United Kingdom February 2024

As predicted by many commentators, the governing council of the ECB (European Central Bank), the Federal Open Market Committee (FOMC) of the United States Federal Reserve and the Monetary Policy Committee (MPC) of the Bank of England, all kept interest rates on hold. All three central banks cited the continuing fight against inflation as the reason for keeping interest rates on hold, but as many experts are predicting, interest rates will fall in 2024 in all three jurisdictions.

The Eurozone

On Thursday 25th January the Governing Council of the ECB announced for the third time in a row that interest rates were being held at a record high of 4%, reaffirming their fight against inflation. Many traders and analysts in the financial markets are betting on a rate reduction at the next Governing Council meeting on April 11th, 2024. 

However, Governor Christine Lagarde announced it was “premature to discuss rates”, though some unnamed members of the council have added that if upcoming data shows that inflation is beaten, then the April meeting could be dovish for a fall in interest rates at the June meeting. Despite these utterances, many in the financial markets believe the ECB have got it wrong and will be forced to cut interest rates in April.

The United States

On Wednesday January 31st, 2024, the Federal Reserve kept policy rates at a 22 year high of 5.25% – 5.50%, where the Chairman of the Federal Reserve Jerome Powell gave a massive endorsement on the economy’s strengths. He further advised that with the on-going expectation of falling inflation, coupled with economic growth, that rates had now peaked and would fall in the coming months. However, despite this pledge, Chairman Powell went on to say that he did not expect a rate cut at their next policy meeting in March, as they wish to see on-going positive data on the reduction of inflation to their figure of 2%. 

Interestingly, the Federal Reserve is hoping to accomplish beating inflation through tighter credit without putting the economy into recession, which historians suggest they only accomplished once in the last 100 years. But with inflation falling more quickly than expected, (2.6% as at close of business 2023), the Chairman is coming under political pressure to reduce rates in March. 

A massively divided country is going to the polls in November to elect a new president, and Chairman Powel received written requests to reduce interest rates from Senator Elizabeth Warren (Dem, former presidential candidate), and Senate Banking Committee Chair Sherrod Brown (Dem). Some market experts are suggesting that there is a circa 63% chance that the Federal reserve will cut interest rates in March, but with seven weeks of economic data to come the markets will have much to mull over.

United Kingdom

On February 1st, 2024, the Bank of England’s MPC announced that it was holding interest rates steady at 5.25%, admitting that a rate cut had been part of their discussions. In the end there was a split decision in the MPC with six members in favour of holding, two members voting to increase rates and one member voting for a drop in interest rates. Interestingly, this is the first time since the Covid-19 pandemic that a rate-setter has voted for a cut in interest rates, and the first time since the global financial crisis of 2008, that there has been a three-way split in the MPC.

Following the announcement, The governor of the Bank of England Andrew Bailey announced that “the level of bank rate remains appropriate, and we are not yet at a point where we can lower rates”. He also pointed out that there is an upside risk to inflation due to continuing trade disruptions, and ambiguously advised how long policy remains restrictive depends on incoming data. However, experts suggest that the Bank of England is now warming to rate cuts in 2024, with officials believing that consumer price inflation will be at 2% in the second quarter, mainly due to falling energy prices., a year earlier than forecasted last November.

Market analysts mainly agree that whatever the statement that comes out of the above central banks, interest rates are set to fall in 2024. It would appear that the Bank of England is set to lag behind the ECB and the Federal Reserve when it comes to cutting interest rates. However, better than expected January US employment figures may delay a US interest rate cut beyond March, and as to whether or not they all fall at the same time, only time will tell.

 2023 Closes with Global Equities Charting Big Gains

As the financial curtain came down, marking the end of 2023, a heart-stopping rally in the last two months of the year showed global stock markets with strong annual gains due to investors betting on the fact that major central banks have finally stopped their monetary tightening policies and will indeed cut interest rates 2024. The MSCI World Index* has, since late October 2023, surged by 16%, and, with a flurry of late trading on the 29th of December, showed an annual gain of 22% . This was reflected in recent data showing that in western economies inflation is falling faster than expected, which, as mentioned above, dramatically changed the perception of interest rate changes. Indeed, Jerome Powell, Chairman of the Federal Reserve, fanned the flames of an equity rally in December by announcing that borrowing cost may have peaked.

*MSCI World Index – This is a stock index maintained by Morgan Stanley International (MSCI) and is designed to track broad global equity-market performance. This index is composed of stocks belonging to circa 3.000 companies from 23 developed countries and 25 emerging markets. 

The rise in global equities as reflected in the MSCI World Index is the best run on an annual basis since 2019, when a similar run reflected a 25% gain. The S&P 500 finished the year up by circa 24% which was mainly due to a massive rally in megacap tech stocks.  European markets, after a lacklustre 2022, posted positive gains in 2023 with Italy’s FTSE MIB charting gains of circa 30% and Germany’s DAX coming in with an impressive 20% increase. The overall increase for European equities was reflected on the STOXX 600* charting a gain of 12.6%. Elsewhere all three indexes in Japan posted hefty gains in 2023 with the Nikkei Stock average finishing the year up 28%, this being the best rally since 2013 which reflected a rise of 57%. 

*STOXX 600  Index – This index tracks 600 of the largest stock exchange listed companies from 17 countries in Europe. The countries represented are Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The big omission from the global rally in stock markets is China, where the world’s second largest economy has suffered from problems in their property sector. As a result, the expected recovery has faltered. Indeed, China’s CSI 300, which measures the largest companies listed in Shenzhen and Shanghai, fell by 11.38%. Their flagship financial centre, Hong Kong, has suffered over the years and in 2023 stocks were particularly hard hit, with experts advising the Hang Seng index is the worst performer of 2023. 

Sadly, in the United Kingdom the FTSE lagged behind their counterparts in the United States and Europe by posting a gain of 4% in 2023. Experts suggest that this is down to a stubborn inflation rate, energy companies that are oil-price exposed, and a preponderance of mining companies that are overexposed to and rely on a slowing Chinese economy.

Many expert strategists seem to be sitting on the fence when calling the outlook for 2024. This year will determine the fate of the political leadership for half the global economy, the final battle against inflation and the fate of the current business cycle. The IMF (International Monetary Fund) has issued figures for world growth in 2024 as 2.9% with investors being excited as the IMF issued growth figures for the Asia Pacific region as 4.2%. Specifically in Singapore, Vietnam and Taiwan, analysts suggest these countries could outperform in 2024 due to the potential upswing in global tech, as they have a high concentration of manufacturing and R&D facilities. All in all many experts are suggesting a wait and see policy, as we see how the US/China relationship unfolds, the on-going ramifications of the Russia/Ukraine war, where interest rates stand in June this year, and whether or not the USA economy enjoys a soft landing.

 Final Call for Interest Rates Going into the New Year

On Thursday 14th December 2023 at the final MPC (Monetary Policy Committee) of the year, after a vote of six to three, the Bank of England maintained the status quo and left interest rates unchanged holding steady at a 15 year high of 5.25%. However, the rhetoric remains unchanged as the Governor Mr Andrew Bailey advised “There is still a long way to go in the fight to control inflation”. 

The governor further acknowledged that despite financial markets expectations, he pushed back against an expected rate cut in May 2024, as the MPC warned they may tighten monetary policy if price pressures persist. The MPC were quick to point out that the two key indicators of price pressure which are service and pay inflation remain elevated, and the United Kingdom remains the only major economy where food price increases remain in double digits, with the UK’s inflation figure of 4.7% being the highest of the G7 countries.

Across the Atlantic Ocean in the United States, on Wednesday 13th December 2023 the Federal reserve once again left interest rates unchanged. However, the Chairman Jerome Powell confirmed that the FOMC (Federal Open Market Committee) is still prepared to resume monetary tightening policies and increase interest rates should price pressures return. 

At the same time, in a more dovish stance,  the Federal Reserve leaned towards reversing their interest rate hike policies, by issuing forecasts that showed a number of rate cuts would be likely in 2024. However market experts pointed out that in November, increases in service-sector costs and in particular housing has kept inflation stubborn enough to counter any Federal Reserve interest rate cuts in the near future.

In Europe, the ECB (European Central Bank), along with their counterparts in the United Kingdom and the United States, kept interest rates on hold for the second meeting in succession. The deposit rate remains at a record high of 4%, even though inflation is heading south. The ECB confirmed that keeping interest rates high will make a substantial contribution to returning consumer price growth to the goal of 2% and they further advised that they will increase the speed of its exit from the pandemic era of stimulus which cost them Euros1.7 Trillion. 

The ECB will also increase the speed at which they are ending reinvestments under PEPP bond buying programme*, putting monetary policy tools into a tightening mode. Financial markets are expecting an interest rate cut in March 2024 despite Christine Lagardem, the ECB’s governors’, comments that policy rates will remain at sufficiently restrictive levels for as long as necessary. Markets noted with interest the wording “inflation is expected to remain high for too long” had disappeared from central bank rhetoric and was replaced with “inflation will gradually decline over the course of the next year”.

*PEPP Bond-Buying Programme – Otherwise known as the Pandemic Emergency Purchase Programme was an ECB instigated response to the Covid-19 crisis. Initiated on the 20th March 2020, it is a temporary asset purchase programme of public and private sector securities. These purchases cover sovereign debt, covered bonds (an investment debt comprising of loans that are backed by a separate group of assets), asset-backed securities and commercial paper. 

Elsewhere and outside of the major central banks, Norway increased interest rates for what is expected to be the final time with Russia also raising their cost of borrowing. Meanwhile, Mexico, Pakistan, the Philippines, Switzerland and Taiwan all maintained the status quo by keeping interest rates unchanged whilst Brazil, Peru and Ukraine all cut their borrowing rates. 

At the end of 2023, whilst the Federal Reserve, the Bank of England and the ECB all kept interest rates unchanged, it appears that the Bank of England will have a different policy to the other two central banks going forward in 2024. Whilst the ECB remains hawkish with an exit from the pandemic stimulus, there is still an anticipation of an interest rate cut in March of next year. The Federal Reserve has been more forthcoming issuing forecasts of interest rate cuts in 2024, with the most hawkish of them all being the Bank of England who are sticking by their statement that interest rates will remain high for as long as deemed necessary. However, recent data showing the UK GDP results being worse than expected may push the Bank of England into reassessing their monetary policy for 2024 forcing them into a small interest rate cut.

The Global Housing Market Crisis of 2023

Sadly, for many people throughout the world, higher interest rates besetting global property markets are diminishing the prospects of home ownership. In 2022 central banks started employing quantitative tightening monetary policy and raising interest rates in their fight against inflation, the resultant shock that rippled through global housing markets gave way to the reality that the real estate boom was at an end, marking a finish to the millions made by people across the globe.

It would appear that higher interest rates are here to stay for a while longer, keeping borrowing costs high, this together with a shortage of homes are keeping prices elevated. This has resulted in those homeowners who have had to reset their loans facing increased financial hardship, whilst in many areas housing is now less affordable. For instance, in the United States the home market is dominated by the 30-year mortgage and today it is effectively frozen, as buyers are being squeezed because those with lower interest rate mortgages are reluctant to sell. 

In each country across there are differing scenarios, but in the end they are all dragging down global economies, as whether they rent or buy, people are using more of their net income for housing. Take for example Canada and New Zealand, where those who bought at the top are now struggling with higher repayments on their loans. Across the world landlords are suffering from distress and in many areas higher interest rates have negatively impacted on the building of homes. 

Experts suggest that the “Golden Age” of single family homes is ancient history with the cost of home loans doubling in some parts of the world. If potential home buyers bought just after the global financial crisis then in most parts of the world owners would now have built up a substantial amount of equity. They predict that the next ten years will be an uphill battle for many new home buyers or even for those looking to trade up. For example, in the United States the current 30-year mortgage is circa 7.4% and over the next decade is expected to be around the 5.5% mark, whereas in the comparable low early part of 2021 it was 2.65%. In 2011 the average 30-year mortgage was circa 3.9% and slowly reduced over the next decade, making it the optimal time to buy.

Interestingly, back in the 1980’s, John Quigley, an economist at the University of California, Berkeley, identified what was to be known as the lock-in effect. Between 1978 and 1981 mortgage rates had doubled from 9% to a staggering 18%, which left millions of households paying well below the market rate for mortgages . Therefore, to purchase a new home meant adding possibly unsustainable costs to the monthly household bills, which was a powerful reason to not to move, hence the lock-in effect.

Economic incentives quite often make people forget lessons learnt in the past, as Quigley’s “lock-in effect” was quietly forgotten as interest rates fell back. However, this all changed when the Covid-19 Pandemic hit. In 2020 the US housing market briefly shut down, then a housing boom exploded (not seen in decades) due to a combination of plummeting borrowing costs and stimulus payments. For the first time in fourteen years existing home sales hit six million annually. The market was seeing house hunters purchasing homes far from the coast (the most popular areas before the pandemic), mainly due to the new remote working policies. Today, the quantitative tightening policies of the Federal Reserve has reduced demand and reduced supply even more due to Quigley’s “Lock-in Effect”

Unfortunately for home buyers, even as inflation begins to recede and central banks reverse their strict monetary policy of interest rate hikes, they have to face the reality that borrowing costs on their mortgages may never return to the lows during the fifteen years seen since the global financial crisis. In the past, if interest rates shot up, consumers were confident that rates would return to what was perceived as normal. They would be able to struggle through the higher rate or take on mortgages with a view to refinancing at a later date when interest rates once again fell. Today, these options will not be available because as previously stated, higher interest rates and costs look like dragging on for quite a number of years. 

Experts in the United States are referring to the housing market as the start of the glacial period due to the collision of the highest mortgage rates in a generation (timeline 20 – 30 years ), a low inventory and rising prices. As a result, recently released data shows sales of previously owned homes having dropped to their lowest level since 2010, with contract closings in October falling by the most in the last twelve months and dropping by 4.1% from September of this year. Further data released from ICE (Intercontinental Exchange Inc) show that the housing market in the United states is the least affordable in forty years. The data further confirmed that circa 40% of average household income is now required to purchase your average home. 

Expert analysts predict that in 2024 the housing market will feel the most severe effects of higher interest rates and sustained higher mortgage rates as they estimate transactions in this market will fall to their lowest levels since the 1990’s. The glacial period that is being deferred on the United States housing market will have many knock-on effects. For instance, families may be forced to live together, and as the elderly age without moving, homes will be kept off the market which could have been made available for purchase by younger buyers. Furthermore, there are a vast number of homeowners who are unaffected by the increase in interest rates (as 30-year mortgages were negotiated when interest rates were low), and they are also sitting on a near-record amount of equity. In other circumstances, there may have been forced sales or foreclosures which would have opened up purchasing opportunities for potential buyers. 

Away from the United States things are just as bad in many housing markets with New Zealand being an extreme case. New Zealand enjoyed possibly one of the largest pandemic booms as in 2021 property prices rose by an incredible 30%, and according to data released by the Reserve Bank, circa 25% of the then current stock of mortgage lending was taken out in 2021 and a fifth were first time buyers. However, mortgages are only fixed for three years or less, and interest rate hikes of 5 ¼% since October 2021 have sent mortgage repayments through the roof. The Reserve Bank has estimated that household disposable income that is used to finance mortgage repayments will be circa 20% by June 2024 up from a low in 2021 of 9%, more than double of what they were paying. However, thanks to strong wage growth many households are just about managing.

In China the property slump is not driven by interest rate hikes, but two years ago a government led clampdown on developers borrowing was the forerunner to a growing crisis. Today, China’s property market, which once accounted for 30% of the economy, is struggling with unresolved debts and slow sales leading to an economic decline. Potential buyers have been reluctant to invest in homes yet to be finished, due to a legal system that is not prepared to restructure debt and spreading defaults by home builders. However, the government has advised that it will target selected developers for financial aid, but insist the funding is to finish housing projects, not to repay debt.

In Canada many citizens profited from the housing boom of the last decade, and by 2020 had come to own more than two homes which, in British Columbia and Ontario, accounted for just under 33% of housing stock. However, data shows the introduction of higher interest rates meant that in a city such as Toronto owning a condo was now yielding only circa 3.5% after mortgage repayments and costs whilst Canadian Government Bonds were paying 5%. The high rates of interest have certainly put a damper on interest in new housing purchases, whilst some with investment properties are facing negative cash flows, forcing owners to sell, if indeed they can find buyers. 

Elsewhere, Europe is facing a housing crisis, as a collapse in home building threatens an increase in shortages over the next five years. Those countries that are hardest hit are among the wealthiest with building permits in France down by over 25% in seven months through to July 2023, and in Germany building permits were down 27% in the first half of 2023. In fact, when Olaf Scholz’s coalition took power in Germany in 2021, the Chancellor’s pledge of adding 400,000 new homes per year was sadly way behind schedule. In fact experts suggest that Germany won’t reach this figure until 2026 at the very earliest.

There is a massive construction crash in Europe with governments reluctant to spend any more funds than are absolutely necessary as they continue the battle against inflation in the post-covid era. Recent data shows that in Sweden in the first ten months of 2023, 1,145 companies within the construction industry filed for bankruptcy, an increase of 32% from 2022. 

Many politicians are advocating more spending on housing, even the Labour party in the United Kingdom (polls suggest a shoo-in at the next general election) are promising to overhaul the planning system and build 1,500,000 over the next term of parliament. However, as in many countries a manifesto promise and reality are often many miles apart. The German government has offered to boost public investment and simplify licensing procedures, but what analysts describe as a tepid response is not expected to make any significant impact. 

Without government investment and private sector investment many citizens across the world  will be unable to buy their own homes destroying the dreams of home ownership. The only winners appear to be those buyers in the United States locked into the 30-year mortgage when interest rates were at their lowest. The rest of the world can only hope that the property market returns to relative normality, but how long that will take is anybody’s guess.

Gold Hits Record High December 2023

This week, gold touched an all-time high of $2,135.39 as the metal continued on a rally which started in early October of this year and has seen the metal gain 16%. Gold last reached a record high back in August 2020, when the Covid-19 pandemic sparked a rush into gold as a safe haven. As the world becomes more volatile, the old adage of gold being a safe haven tends to make it increase in value.

This of course can be seen in the continuing war between Russia and Ukraine, as well as the continued conflict between Israel and Palestine, providing a geopolitical risk as a reason to invest in gold. Furthermore, the dovish stance being taken on interest rates by the Federal Reserve in the United States has given the gold price some staggering momentum.

When the Federal Reserve first started hiking interest rates, assets such as bonds became more lucrative for investors due to the higher yields on offer. Consequently, the demand for gold lessened due to the fact the metal carries no interest rate thus diminishing investor appeal. Conversely, when interest rates come down the appetite for gold increases, and the prospect of easing money supply and reducing interest rates appears to have been confirmed by recent comments coming out of the Federal Reserve.

Analysts are advising that gold’s surge towards a record high was aided by Federal Reserve Governor Christopher Weller, who indicated that interest rates will not have to be increased to get inflation to return to 2%. Further dovish remarks followed from the Chairman himself, Jerome Powell, who said the central bank’s policy rate was now well into restrictive territory, which suggests that rate increases have now concluded.

This potential end to rate hikes will prove beneficial to gold, as the metal tends to struggle under higher rates whilst benefiting from lower rates. Therefore, as mentioned above, gold is not only rising from geopolitical risks, (also 41% of the world’s population will go to the polls next year,) but from traders aggressively pricing in rate cuts from March 2024. Indeed, experts advise that the swaps markets are now predicting a better than even chance of a rate reduction in March 2024, and are pricing in a cut in May of the same year. The recent decline in the value of the dollar has also spurred investor interest in gold as the metal is usually valued against the greenback. 

Experts suggest that gold may well go higher as there are many investors still on the side-lines, which increases the possibilities  of further spikes/rallies in gold. Previous gold bull markets have been driven by investors using exchange-traded funds or ETFs*, but analysts advise that investors in the mechanism have seen sellers for much of 2023 down 20% from the high of 2020. 

*Gold ETFs – This is a very popular way for investors to buy gold as they do not have to go through the process of owning the metal. Gold ETFs enjoy good liquidity and investors can buy and sell shares of the ETF on the stock exchange. When a purchase of shares is made the fund manager must buy the equivalent amount in physical gold. This not only will increase the price of gold but can act as a signal to the broader market that demand is increasing thereby impacting investor sentiment.

Furthermore, experts advise that the current price of gold (down at the time of writing form the high of USD2,135.39 to USD2019.17) may well be underpinned by the continuing support of purchases by governments and central banks. For example, Poland has bought circa 300 tonnes of gold in the past few years falling in line with the Eurozone average of gold to GDP ratio. This is a covert requirement* and as such analysts suggest Poland will buy an additional 130 tonnes of gold. 

*Covert Requirement – is referred to because some central banks within the Eurozone (e.g., Belgium) refuse to be transparent with regard to the gold reserve alignment on the grounds of professional secrecy. 

Market sentiment appears to favour a bull run in 2024 as experts predict that the Federal Reserve will cut US Dollar interest rates four times in 2024. However, if inflation figures do not match market sentiment and rates are put on hold or even hiked once more, traders and investors will not hesitate to cut their positions and gold will fall back to weaker levels.