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GBP borrowers choose to fix as yield curve flattens
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GBP borrowers choose to fix as yield curve flattens

Rhona Macpherson Weekly bulletin June 2019
The downward shift in interest rate expectations has created an interesting environment for GBP borrowers. The five year swap rate is currently just 0.06% above three month GBP LIBOR, and the difference is even less for shorter dated maturities. Unsurprisingly, swaps have therefore become the hedging instrument of choice for borrowers, with option-based products such as caps being pushed into second place.
Where now for GBP swap rates?

Is now the best time to fix floating rate debt? Following the MPC meeting in May, Bank of England Governor Mark Carney warned the true potential for interest rate hikes was not priced into the market – and the market roundly ignored him. That feels like a long time ago. Indeed traders now seem to think a rate cut is more likely than a hike, perhaps as early as this autumn.

Much of the change in sentiment has been driven by politics. With Boris Johnson having emerged as the front runner in the Tory leadership contest, markets are once more contemplating the possibility of the UK leaving the EU without a deal. As a result, gilt yields and swap rates have continued to nudge lower, with the curve flattening further in the process. A set of surprisingly robust economic data releases has been brushed under the carpet, as investors choose to worry about geopolitical sabre-rattling instead.

US trade war

A similar theme dominates in the US. Trade tariffs imposed by President Trump have depressed investment, impacting global trade and manufacturing. Over the weekend, China stepped up its rhetoric against US tariffs, describing Washington’s recent actions as “intimidation and coercion”. It also emerged that Australia may be an addition to Trump’s list of targets following reports last week that Mexico has also been singled out. Given the likelihood of import tariffs being passed on to the consumer, growth prospects are dimming.

No wonder the Fed chose to send a message of patience in the minutes following its May meeting. At the beginning of the year the market had expected a steady series of rate hikes, but that has been put on hold. Indeed, recent comments from Chairman Powell were taken as a signal that rates are set to fall. On the flip side, record-low unemployment and robust inflation would be an unusual backdrop for a rate cut.

Uncertainty prevails

A quick scan of economists’ commentary brings a recurring theme: “uncertainty”. For the UK, Brexit is the dominant topic, for the US it’s escalating trade disputes and tariffs. Both have caused a dip in sentiment which in turn has discouraged investment.

Uncertainty is inherent in financial markets, but this is a particularly challenging period. Brexit is far from resolved, and when it comes to trade tariffs the supply chain is far too complex for the fallout to be limited to those countries at loggerheads with each other.

For floating rate borrowers, the ability to have certainty over future interest rate costs is always attractive. But the uncertainty inherent in the current geopolitical backdrop has made that certainty more valuable than ever.

Upcoming data releases

A busy week for economic data releases,including the following:-

Monday 3rd June

  • US Construction Spending April is expected to reveal a small increase of 0.3% in May

Tuesday 4th June

  • UK construction PMI survey for May is expected to remain at 50.5
  • EUR inflation rate Flash May is expected to be 1.3%
  • EUR unemployment rate Apr is forecast to remain the same at 7.7%
  • US Factory orders APR

Wednesday 5th June

  • EA Market services PMI MAY survey expected 52.8
  • EA PPI APR forecast to increase 0.3%
  • EA Retail Sales are forecast to have fallen 0.3% in April
  • US Fed Beige Book

Thursday 6th June

  • ECB monetary policy decision followed by press conference
  • EA GDP Growth rate 3rd Estimate Q1 consensus is 0.4% q./q and 1.2% y/y
  • US weekly initial jobless claims forecast to be up 215k
  • US Balance of Trade data MAY expected to be -$50.7bn
  • US Unit Labour Costs Final Q1 is forecast to show a fall of 09.8%

Friday

  • UK Halifax house price index
  • US Non-Farm Payrolls MAY expected to be up 183k
  • US Average Earnings MAY expected to show a rise of 0.3%
  • US Unemployment Rate MAY should stay at 3.6%
  • US Wholesale Inventories MAY forecast to show an increase of 0.7%

Speeches

  • UK BoE Ramsden (Wednesday 5th June)
  • UK BoE Governor Carney (Thursday 6th June)
  • Various Fed officials are due to speak including Fed Chair Powell on Tuesday but also the Fed’s Quarles. Daly, Williams, Clarida, Kaplan and Bostic are scheduled

For more information, please contact Rhona Macpherson, Associate Director at JCRA, at Rhona.Macpherson@jcrauk.com.

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