Flattening yield curves present a valuable opportunity
The big story of last quarter was the flattening of yield curves across most major economies. In the US, this was presaged by an unexpectedly dovish turn in the FOMC’s January press conference. The Fed chairman, Jerome Powell, announced that he was putting the brakes on further interest rate hikes in 2019, citing lacklustre inflation and concerns over global economic growth. The ECB followed suit a couple of months later, with Mario Draghi stating that he expected to keep rates on hold until at least the end of the year. Market consensus is that he will do so until at least the middle of 2020 – understandably so, with Italy in recession and the European Commission’s forecasts now pointing to a slowdown across the Eurozone as a whole.
In the UK, commentators are of course blaming Brexit for falling interest rate expectations. It is true that the Bank of England is unlikely to raise rates until we have some kind of clarity over our future relationship with the EU. That said, considering both the global economic environment and the fact that the possibility of a no deal Brexit seems to have receded, this explanation should be taken with more than a pinch of salt.
Whatever else falling yield curves may imply, they have presented our clients with a valuable opportunity to place new hedges and extend existing ones at attractive prices. It bears repeating that the market for hedging products is in one respect just like any other: the best time to enter it is precisely when the consensus view says there is no point.
Turning to the FX markets, movements have been much more muted than one might have expected given the geopolitical backdrop. For sterling crosses in particular, speculators seem to have decided that making calls based on the outcome of Brexit is a fool’s game. While they are probably correct, a less benign consequence of this line of thinking has been a reluctance by some corporates to continue implementing their ongoing FX hedging strategies. This is often driven by a fear of “missing out” on sharp, beneficial movements further down the line – although it should be remembered that losses from unhedged positions can be just as sharp! Perhaps because of this, recent months have seen a particular burst of activity in deal contingent FX hedging of acquisition costs.
It will be an interesting few months for all markets as we approach the third (and not necessarily final) “Brexit date”. We look forward to continuing to guide our clients through the uncertainty ahead.
JCRA recently recorded a webinar, “De-risking FX volatility”, in conjunction with Capital Economics. You can listen here.
For more information, please contact Francesco Podestà, Director, Private Equity at JCRA: Francesco.Podesta@jcrauk.com.