The conviction that central banks could start cutting interest rates by early Spring is “overly optimistic”, according to one of the UK’s largest advice firms.
Richard Carter, head of fixed income at Quilter Cheviot, the discretionary fund management arm of the advice network Quilter, said: “While central banks are likely to start cutting interest rates as the year goes on, we think the market may be overly optimistic in expecting the Federal Reserve to start easing policy as early as March.”
This sentiment was echoed by Gina Gopinath, deputy managing director of the International Monetary Fund. She told delegates at the World Economic Forum in Davos today (January 16) that the markets’ expectation that rates would be aggressively cut was “premature”.
The timing of rate cuts has ramifications for bond investors. Yields are still high - the US 10-year Treasury is around 4 per cent while the UK 10-year gilt is at 3.8 per cent - but interest rates are expected to come down.
Falling interest rates are typically good for bond investors because bonds pay a fixed interest rate which becomes more attractive as the average rate on the market falls. This increases demand and pushes up the price, making money for existing bond holders.
Market sentiment has shifted, but in general the US is expected to cut rates by about 1 percentage point this year, while the UK is expected to cut rates by 1.25 percentage points.
Jason Hollands, from wealth manager Evelyn Partners, said: “The key issue hanging over fixed income markets remains the ever-adjusting expectations of when interest rate cuts will commence.
“Only a month ago, the markets were factoring in a very high probability of cuts in the US, commencing as soon as March. However, since that conviction has been sapped somewhat.”
It has been a similar story in Europe. The chief economist of the European Central Bank, Philip Lane, said that there was often “another inflation wave” if central banks tried to “normalise too quickly” before the problem was properly conquered.
If inflation then rose again, there would be another wave on interest rate hikes which would be a “much worse scenario”.
Asset allocation
The shifting backdrop muddies the water for fixed income investors. More than £18 billion was invested in government bonds (UK and US) in 2023, according to data from Morningstar, thanks to rising yields.
Last year, advice firms were doing the same. Quilter told FTAdviser that it had increased its fixed income allocations for clients in 2023 and had benefited from this in the final quarter of last year.
Carter added: “We believe the backdrop for bonds remains quite positive as inflation pressures are easing while growth is fairly anaemic, especially in the UK and Europe.”
Evelyn Partners, the wealth manager, also increased exposure to government bonds last year, but was less bullish about the bond market for 2024.
