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Interest rate hedging strategy recommendations Back  
A panel of Ireland’s leading economists and analysts predict that after a further decline later this year,
interest rates are set to rise in the Eurozone, US and UK over the next three years.
Panelists recommend switching to fixed rate

With interest rates expected to rise in 2004, now is the time for fixed rates, say economists.

Lorenzo Codogno, co-head of European economics, Bank of America, London
Watch out for interest rate rises! Long-term yields on government bonds are at recession levels. They are not consistent with the expected state of the global economy as suggested by leading indicators (and our own forecasts). At 3.8 per cent, the bellwether 10-year US government bond yield is probably still discounting some war-related risk premium, the still high uncertainty of the economic environment, and the shift in household portfolios towards ‘safe’ assets.

However, as clear signs of economic recovery emerge-and this may well happen sooner rather than later-long-term rates will move higher. This is consistent with the continuation of the current narrowing trend in corporate bond spreads. The de-leveraging in the capital structure of companies recorded over the past couple of years has reduced the risk on the expected profit streams, and thereby abated volatility in the stock market and justified the perceived lower risk of corporate bonds. The contraction in corporate bond spreads will likely continue as the economy rebounds. In the Eurozone, with the 10-year benchmark Bund yield close to 4.0 per cent there seems to be no significant value in relative terms. However, the delayed and more gradual recovery in Europe will probably justify long-term rate spreads disappearing and then becoming negative over time. Expectations that long-term rates will move higher in the US, then in Europe will also be supported by monetary policy developments.

Consistent with the US economy accelerating to an annualised 2.5/3.0 per cent growth in 2003, and above 3.0 per cent thereafter, the Fed is unlikely to ease further. However, the Fed will also be cautious about tightening, even after economic improvement emerges. The FOMC’s first tightening move will likely be recorded in 1Q04, with the Fed funds rate expected to be lifted to 3.5 per cent at the end of 2004, and 4.25 per cent at the end of 2005. The ECB will have extra time to leave rates very low, as the huge appreciation of the euro will keep a lid on inflation at least until mid-2004. Thus, Eurozone official rates may well remain at 2.0 per cent until mid-2004, rise to 3.0 per cent at the end of next year and to 4.0 per cent at the end of 2005. In the case of the Bank of England the expected moderate decline in UK house prices will drag down private consumption and moderate the pace of growth for the overall economy.

The Bank of England will likely continue to ease monetary conditions during the course of the current year, with the base rate expected at 3.0 per cent in 4Q03, and then to remain steady until the beginning of 2005. As central banks will be in no hurry to tighten, yield curves in major markets will remain steep for a while. Even long-term rates are unlikely to move sharply higher. While the economy will gather momentum over the coming quarters, inflation will remain pat, and thus the upside risk for long-term rates is not very large. US 10-year government yields should stabilise slightly above 5.5 per cent in 2004-2005, while in Europe they will be much slower to get to roughly the same level.

Niall Dunne, economist, Ulster Bank
The recent round of rate announcements saaw the Federal Reserve Bank in the US, the Bank of England and the European Central Bank all decide to keep their short-term interest rates on hold. However the futures markets are now pricing in imminent rate cuts in Europe, Britain and the US with high levels of certainty. And in the near term we do expect that there will be further rate reductions in both Britain and Europe. This will take the UK MPC Repo rate back to 3.50 per cent, and the ECB Refinancing rate down to 2.25 per cent - an historic low since the ECB assumed its stewardship of Eurozone monetary policy. However it is our opinion that conditions in the US will have to deteriorate significantly further before we see a reduction in the US Fed Funds Rate below its current 1.25 per cent level.

So following the two cuts we expect over the coming months, the primary global short term interest rates should remain at EU 2.25 per cent, UK 3.50 per cent and US 1.25 per cent until year end.

Given that we expect short-term rates to fall further from present levels, we are advising our customers that short term hedging solutions should utilise caps and collars, rather than fixing. Effectively we are advising customers that they should take out some insurance to protect against the unforeseen, but insurance that allows them to benefit from the further decreases that the market and we expect in interest rates. Therefore, as we expect further rate cuts in the short term, fixing is not considered appropriate for short dates.

Looking to the long end of the yield curve, our advice differs, reflecting our differing view. Starting with Europe, we remain close to the lows seen at the time of EMU commencement, and markets are beginning to show resistance to rates going much lower. As a result we are seeing increased interest in long term fixing. The bulk of this activity has been for fixings of 5 years or longer. Given that markets are not at historical lows, but only fractionally off them, we are happy to advise that customers fix for 5 years and beyond. We have seen some shorter-term fixings, but as we’re not certain that the Eurozone recovery implied by the 2 and 3 year rates offered in the market is guaranteed, our preferred strategy in the 3 year-and-under horizon is to utilize Caps or Collars.

Looking to the US, all dates past the 1-year horizon offer good opportunities for fixing. The reduction in interest rates in the US has been the most severe, and likely to be reversed the quickest. We’re also hopeful that there will be a moderate turn-around in US economic health this year. Therefore we are happy to recommend that customers fix when looking beyond the short dates.

I am also worried that President Bush’s tax plan could push longer dated interest rates higher, if it is passed in its entirety. The only way the US will be able to offset its burgeoning deficit will be through bond issuance, and by increasing the supply of Treasury-backed fixed income securities available, bond prices will fall, sending bond yields higher. Higher yields will effectively pull interest rate expectations higher in turn. Therefore now is a good time to fix longer-dated US exposures.

Finally looking to the UK, a gradual increase in interest rates is expected over the forthcoming years, and therefore we are happy to advise customers that they can fix longer-dated exposures at present levels. In fact, longer-dated UK rates are only just off historic lows, so customers that lock in at these levels will be securing excellent value.

The only caveat to this UK forecast is that it is possible that the UK will decide to join the UK at some stage inside the next 5 years. If this does happen, British interest rate expectations across the curve will fall. However this is some way off yet (2006 at the earliest), so fixing at present levels still represents good value.

In conclusion, this brings me to the last piece of advice that we give to customers - hedging strategies should be dynamic and subject to review. In a volatile market, the optimal hedging strategy to adopt is one that constantly reviews exposures. Even fixed exposures should be subject to regular reviews, because markets are not static.

Noel Griffin, associate director, Treasury, Bank of Scotland (Ireland) Ltd
The long period of falling interest rates will peter out over the coming months in the European Union, the United States and Britain. Interest rates will rise gradually as all three economies experience stronger growth in 2004 and 2005.

Given the historically low interest rates at the moment, borrowers are advised to fix at least 50 per cent of their borrowings.

While there is some prospect of marginally lower interest rates in the short term, particularly in Britain, the potential is clearly limited. In any case, the decision to lock in some or all borrowings to a fixed rate brings certainty to the cost of these borrowings.

Euro zone interest rates will have one more cut of .25 per cent for 2003 as the European Central Bank (ECB) is very conscious that consumer confidence continues to be weak and unemployment continues to be high in the European Union, particularly in Germany. In addition, inflation continues to be a concern.

But by the beginning of 2004, low interest rates and more stable oil prices will have improved business confidence. This will prompt the ECB to increase interest rates to 3 per cent by the end of 2004.

Building on the solid if not spectacular growth of 2004, the economic upturn in the euro zone will continue with a return to growth as the world economy picks up and confidence is restored.

In order to counteract any inflation risk, the ECB will continue to raise interest rates throughout 2005 to finish the year at 3.75 per cent.

US interest rates will remain at the current level of 1.25 per cent throughout 2003. Weak labour markets coupled with continuing weak manufacturing and services have lowered consumer confidence.

However, low interest rates and the US success in the Iraqi War will ensure consumer confidence increases through 2003 and 2004. This will lead to better growth, stronger equity markets and higher exports caused by the weaker dollar.

Once consumer spending picks up, the US Federal Reserve will increase rates by 1.25 per cent throughout 2004 in order to head off inflation.

The strong growth in 2004 should continue in 2005 - but at a slower pace.

The Fed therefore will continue to raise rates and by the end of 2005 rates will be at 3.75 per cent.

The Bank of England will most likely cut UK interest rates in the near future. The cut is expected due to falls in exports, retail sales and consumer confidence.

But UK rates will start to increase in 2004 as weaker sterling benefits exports, consumer confidence rises and the housing market strengthens due to the lower interest rates. In addition the stockmarket will recover leading to stronger consumer spending. Therefore UK rates will finish 2004 at 4.00 per cent.

The UK economy will continue to strengthen in 2005 in line with continuing improvement in the world economy. The Bank of England will continue to raise rates in an effort to control inflation resulting in a rate of 4.5 per cent by the end of 2005. If by then the UK is considering adopting the single European currency, there will of course need to be convergence with euro zone rates.

Austin Hughes, chief economist, IIB Bank
The driving forces determining long-term interest rates are likely to be global in nature in the next year or two. Problems with weak activity and a poor budget outlook, coupled with expectations of lower inflation are common to most economies at present. As a result, the key issue for any forecast that seeks to take ‘a long view’ on rates is to identify if and when the array of exceptional factors that have driven interest rates down in the past couple of years will cease to dominate. On our reckoning, we have not yet seen the low point for official rates. We expect further Central Bank action on both sides of the Atlantic in the next month or two.

Markets will then have to again ask whether this further easing will be sufficient to spark recovery in the global economy when the massive cumulative easing of the past few years seems to have failed. In attempting to answer this question, investors may focus on the prospect of ‘unconventional’ easing encompassing Central Bank purchases of bonds. The possibility of a prolonged period of low official rates may also become an important issue for term rates. In such circumstances, interest rate markets could be quite volatile with a pronounced bias towards softer yields.

Beyond the next few months, we expect to see a modest and uneven recovery in the global economy take hold in the absence of a further negative shock. The cumulative impact of a massive interest rate and budget easing in the past couple of years should sustain household spending long enough to allow some improvement in business spending. Firms should progressively respond to the scope for new and replacement capital spending to deliver returns that meet or beat expectations that have been sharply scaled back of late.

We reckon the later stages of 2003 and the early part of 2004 could remain volatile but with a firmer bias to yields because the transition to a modest economic upswing is unlikely to be a steady process. Even tentative signs that a substantive recovery is becoming established will re-ignite concerns about heavy supply. The realisation that official rates are currently far below levels traditionally seen as ‘neutral’ will also concern investors. For these reasons, we think a period of pronounced yield curve steepening could be in prospect during next year.

FX movements could be a further source of instability in interest rate markets. There appears scope for pronounced dollar weakness over the forecast period. This should encourage the ECB to cut rates and to hold them relatively low for much of 2004. In the second half of 2004, we expect the US recovery will be sufficiently strong to enable the Federal Reserve to begin raising rates. Because we expect to see pronounced signs of a slowdown in the UK economy in the near term, we expect the Bank of England to be very ‘active’ in the second half of this year. That same approach could lead to a sharp rebound in UK interest rates through 2004 as a global upswing takes hold.

Oliver Mangan, chief bond economist, AIB Global Treasury
Although, central banks have been busy slashing interest rates since the start of 2001, the world economy is on course for a third successive year of below trend growth in 2003. This does not imply that monetary policy has become totally ineffective. Economic growth would almost certainly be much weaker had interest rates not been cut sharply over the past two and a half years.

However, the effectiveness of monetary loosening has been curtailed by a host of factors which are acting to restrain global growth. Chief amongst these is the ongoing correction of the late 1990s bubble imbalances, most notably in the US. Excess capacity, the sharp stock market falls, the rebuilding of corporate balance sheets and the need to improve household finances are all restraining economic growth.

Long term structural factors are also inhibiting growth in Europe, especially Germany. Rigidities in labour and goods markets, high taxes and the deadweight of East Germany are depressing activity in Europe’s largest economy. Japan, meanwhile, is battling deflation, negative demographics and the continuing fall out from its bubble economy of the 1980s.

While these negative growth factors should ease somewhat, they are unlikely to completely abate anytime soon. Growth in 2004, though, should be boosted by lower oil prices, reduced geopolitical tensions and the stimulatory stance of fiscal and monetary policy.

However, while activity should strengthen in 2004, the best that the world economy may achieve is a return to trend growth. Activity could remain weak in the eurozone and Japan, in particular, given the negative long term structural factors at work. It could be 2005 before we see a return to above trend global growth.

This growth outlook, combined with a very subdued inflationary environment suggests that interest rates will remain low for some time. Indeed, central banks may cut rates even further this year, especially in Europe, where economic growth remains particularly weak.

Rate hikes in 2004, in response to strengthening activity should be quite modest. Concerns about deflation in the US suggest that the Fed will be slow to tighten policy. The weak eurozone economy may require a prolonged period of low interest rates. Thus, we think that official interest rates in the US and eurozone may end 2004 in a 2 to 3 per cent range.

Bond yields are relatively low at close to 4 per cent for ten year government paper in the US and eurozone. Yields should remain low in the near term but can be expected to move higher in 2004/05 on signs of strengthening economic activity. Yield curves are relatively steep, though, so the rise in bond yields further out the curve should be relatively modest.

Low longer term rates implies that this is now an opportune time to lock into fixed rate loans. However, the prospect of continuing low official interest rates suggests that borrowers should not pay much of a premium to move from variable to fixed rate loans, especially on short term fixed rate loans.

Dan McLaughlin, chief economist, Bank of Ireland
In general, analysts and economists do not have a good record in terms of spotting turning points in the economic cycle, be it downturns or recoveries. There are a number of reasons for this but one simple and important factor is that current conditions tend to heavily influence future expectations. For example, we now know that the US recession of 2001 ended in the final quarter of that year, or around the time of the ‘9-11’ attacks, although at the time many commentators became much more gloomy about near term economic prospects.

Similarly, pessimism about the prospects for the global economy intensified in the early months of 2003, following a series of weak economic readings, despite the fact that the uncertainty over the timing, duration and impact of the Iraq war was already having a strong influence on consumer and business sentiment.

Since the war’s relatively quick resolution, oil prices have fallen sharply, equities have rallied strongly and consumer confidence has rebounded, at least in the US. The big question is whether all of this translates into real gains in production and economic activity, and it is probably too early to give a definitive answer.

Certainly the Federal Reserve thinks so, but there are other reasons to be optimistic about an upturn, quite apart from the positive movement in equity markets and the fall in energy costs. The business spending cycle appears to have finally bottomed, led by a recovery in spending on computers; a fact illustrated by the recent trend in US factory orders, industrial production and the performance of semi-conductor shares. Interest rates are also extraordinary low, which should help to bolster a broader recovery in business spending and underpin the consumer. Consequently, I expect global growth to surprise to the upside in 2003 and 2004.

On that basis, we are at or near the bottom of the rate cycle. The Fed funds rate may not fall below the current 1.25 per cent and start rising in early 2004, moving back towards a more neutral rate of 5 per cent by the end of that year. Similarly, the current rate of 3.75 per cent may well prove the low of the UK rate cycle, with the resilience of the housing market providing an additional reason for the MPC to begin to tighten policy in late 2003 or early 2004. Again a return to a more neutral rate is likely by the end of 2004, implying a UK repo rate of 5 per cent.

The ECB tends not to be as pro-active as either the Fed or the ECB, so a further cut may well be in prospect, with the monetary cycle somewhat behind that of the other major central banks. Consequently, a 2.25 per cent rate is probable by end-2003, with higher rates likely in the late spring of 2004. Again, though rates will be higher at the end of that year with a repo rate of 4 per cent heading towards 4.5 per cent by mid 2005.

On that basis, borrowers might be well advised to consider fixing. For many it is difficult to look at borrowing at a higher rate that the current floating option, but as we have seen in the past, once the cycle turns, swap rates can move up very quickly. The best time to fix is just before the turn of the cycle, which is always hard to call, but fixed rates are now at levels which tilts the balance towards fixing at least some of one’s exposure.

Alan Mc Quaid, chief economist, Bloxham Stockbrokers
The current global economic climate is one of huge uncertainty. With the war in Iraq now out of the way, there is optimism in many quarters (including the Federal Reserve) that the US economy/world economy will pick up slowly but surely in the second half of the year. However, it is by no means guaranteed that things will improve for the global economy in the short-term, especially now with the SARS flu virus spreading the world. However, the US Federal Reserve has made it quite clear that it will do whatever it has to, to the get the American economy motoring again.

The overall world policy environment is stimulative. Fiscal policy is mildly expansionary in the major economies, and monetary policy is highly accommodative by historical standards. Real-short interest rates are low and yield curves are steep. However, the recent deceleration in global growth indicates that more policy stimulus may be needed to counter economic headwinds. Fiscal policy will not provide sufficient near-term support, so the onus is largely on monetary policy. The Fed has to play the leading role given that the US drives the global economy and financial markets. Fortunately, prospects for additional monetary policy support in the near-term are favourable.

• The Fed would probably like to wait and see what the post-Iraq environment brings on the economic front, and may not be that keen to cut short-term interest rates again unless it really has to, but there is no doubt that it will do whatever is needed to get the US economy motoring again. However, policy moves may shy away from cutting the fed funds rate again, and shift to buying long-dated US Treasuries directly. My overall view is that US rates will remain on hold for the remainder of this year (though a further cut of 50bps before end-June cannot be entirely ruled out), and will rise in 2004 and 2005 as economic activity picks up. However, even by end-2005, I still see US rates below 4.00 per cent (what is generally perceived to be the ‘neutral’ level) as inflationary pressures remain fairly subdued.

• The Bank of England is also signalling that it is ready to act. The MPC, of course, is in a more precarious position than the Fed because inflation is already bumping up against (now above) the Bank’s targeted 2.5 per cent ceiling. However, growth is clearly faltering and the Bank fears that weakness in the global economy and in financial markets could reverberate back on to the UK. Furthermore, there are signs that some of the steam is coming out of the housing market. In overall terms, the MPC has ample ammunition to combat downward pressure on the UK economy, if it so desires, and I see rates ending the year no higher than 3.50 per cent. That said, the Bank cannot go on ignoring the worsening inflation trend indefinitely, and as growth starts to rise, the MPC should move back into tightening mode. The overall level of tightening over the next couple of years should be less than the Fed and more than the ECB, because the UK economy is likely to grow faster than Euroland but slower than the US over 2004 and 2005.

• It is more difficult to read the ECB. It stated at the start of the war in Iraq that it was ready to act to support the Euroland economy if necessary. But ECB President, Wim Duisenberg, noted recently, that “it is not possible to assess what effect they (war and geopolitics) will have on the global economy”. The Bank believes policy is already quite accommodating, a point reiterated by a number of ECB officials in the past few weeks. But, with inflation starting to come back closer to its 2.0 per cent ceiling, the euro continuing to rise, and little sign of much improvement in the Euroland economy, further rate cuts are inevitable in my view, in the short-term. I am looking for another half percentage point to be taken off rates this year. On the assumption that the Eurozone economy picks up momentum through 2004 and 2005, interest rates should start to rise again, but the level of growth and inflationary pressures should not be sufficient to warrant any more than 50bps of tightening next year, and 75bps of tightening in 2005.

As regards long-term interest rates, a lot will depend on measures the Fed might adopt to stimulate the economy. There have been widespread rumours in the market recently that the Fed intends to directly buy long-dated Treasuries. Such a move would undoubtedly keep long-term rates down, not only in the US but in Europe as well. Against that, the fiscal loosening across the globe and the widening of budget deficits has to have a negative impact at some stage. According to a recent report published by the Federal Reserve’s Board of Governors, an increase in the projected GDP/debt ratio of one percentage point will raise long-term rates by 25bps. The Fed study cites official projections that the deficit as a percentage of GDP will rise from less than 0.5 per cent of GDP at present to between 2 per cent and 4 per cent in the next five years, which implies a tightening of long-term rates on this basis of up to 100bps over the period. Long-dated rates in the UK and the Eurozone are also likely to rise but not as much as in the US. I think Eurozone long-dated rates will be the lowest of the major countries in two years time.

Locking in to the current low level of rates is a recommended option, though rates should be lower in a couple of months time. All in all, though, I don’t see interest-rates rising that much over the next couple of years, with rates likely to remain low by historical no matter what happens.

As regards fixed or variable, this is really a matter of individual choice (with fixed rates offering peace of mind in a volatile environment) but my preferred option would be variable, as I don’t see a huge level of official monetary tightening over the next few years, unless inflation gets out of hand (which looks highly unlikely). Indeed, rates are likely to remain low by historical levels. Obviously, some 1 to 3-year fixed options may be attractive, but I wouldn’t be inclined to fixed longer than this, unless absolutely necessary and/or the offer rates provide better perceived value to the variable rates.

Donal O’Mahony, global bond strategist, Davy Stockbrokers
Interest-rate forecasters have far from covered themselves in glory over the past couple of years, having singularly failed to anticipate the degree to which both short and long-term rates were forced lower by the advent of post-Bubble disorder. On the contrary, the analyst community have, in the main, been doggedly pre-dispositioned towards a ‘normalisation’ of interest rates from the ‘emergency’ readings of the recent past. This reflects, in part, an initial ‘don’t fight the Fed’ mentality which clung to the (ultimately erroneous) belief that aggressive official interest-rate reductions would work the oracle in restoring vigour to the US and global economy. More recently, a degree of moral hazard may have drifted into the interest-rate prognostications, with the widespread aspirations for a recovery in stock-market performance looking more credible in the context of a back-up in bond yields (given the negative correlation between equity and bond market performance since 2000).

Sadly, glory is set to remain an elusive adornment for interest-rate forecasters for quite some time to come. The relative pessimism which still abounds vis-‡-vis official rate and (especially) bond yield forecasts over the next two years sits most incongruously with a US-centric global economy that continues to sputter along at stall speed, still weighed by excess capacity, over-indebted balance sheets and abject corporate profitability, and all of the foregoing attributable to the destructive excesses of the late 1990s Bubble age. It is a world economy for which growing debt deflation risks now loom large, a truly appalling vista for fiscal and monetary policy-makers who have all but shot their bolts in shoring-up the anaemic growth performance of the past two years.

Sufficiently appalling, it appears, for the Federal Reserve to change it’s behavioural instincts of the past several years. Gone is the ‘opportunistic disinflation’ experiment of yore, by which above-trend growth rates were tolerated without any rate rise if inflation pressures refused to surface on the Fed’s radar-screen. In its place is now an ‘opportunistic inflation’ alternative, this involving an asymmetric bias to lowering interest rates in order to stave off creeping deflation risks. Such a revised modus operandi involves not only short-term rate management (via an even lower Fed funds rate) but also longer-term interest-rate manipulation (ie the fabled Plan B) as a means of circumventing the Fed’s imminent zero-bound constraint regarding conventional monetary policy.

What is key in all of this, however, is not only that interest rates of all maturities have further to fall, but that they will also stay lower for longer; indeed, for as long as it takes for a healthy dose of inflation to be re-engineered by such ultra interest-rate accommodation, thereby removing the potentially ruinous consequence of a broader-based deflationary outbreak. The problem for the Fed (and all other central banks) is that such inflation pressures will be painfully slow to rebuild. The output gaps that have progressively widened in the post-Bubble aftermath will take some closing, requiring as they do a prolonged period of above-trend growth in the global economy that will be difficult to achieve in a deleveraging environment.

In sum, the surprise of the next two years will be not too dissimilar to that of the last two viz. the sustained decline in the term structure of interest rates to levels alien to the current generation of investors. Yield curves will continue to steepen to historic peaks until such time as unconventional monetary policy (Plan B) holds sway, at which stage a bull-flattening will be triggered by the ‘carry trade’ activities of the Federal Reserve, banks, and end-investors alike. The time for borrowers to switch their liabilities from variable to fixed rates will ultimately arrive...but at altogether lower interest rates!

Jim Power, chief economist, Friends First
Interest rates in all of the major jurisdictions are now close to or at the lowest levels in about 50 years. Such exceptionally low interest rates have been engineered to deal with pretty exceptional economic circumstances. Since the bursting of the US economic and equity market bubble in 2000, the global economy has been in the doldrums and has struggled to emerge from conditions that have been at or on the brink of recession. At the same time inflation is also close to historic lows so central bankers in general can afford to be quite relaxed about the world. Over the next 6 months or so there is a reasonably high probability that rates in the 3 jurisdictions under consideration can fall a little further as the respective economies struggle to emerge from an economic environment that is being stifled by the necessity to purge the excesses of the US bubble period out of the system. In terms of probabilities, the ECB is most likely to cut, perhaps by as much as another 50 basis points. However, forecasting the activities of Wim and his band of merry soldiers is a task fraught with danger, such is their unpredictable nature. However, in an environment where Germany will continue to drag the rest of the euro zone down, the case for lower rates is very strong, but as we have learned since 1999, what ought to be done and what will be done are often two different things. In the US and UK, there is a lower probability of further cuts, and if delivered they are unlikely to exceed 25 basis points in magnitude. Looking out beyond the next 6 months, provided as expected, the global economy recovers in a gradual and modest fashion, the 3 central banks under consideration will probably seek to gradually tighten rates from exceptionally low levels to a level something closer to normality. However, assuming my general rate projections are close to the likely outcome, rates at the end of 2005 will still be low in a historical context. Hopefully, I am too conservative in my estimates; because higher rates would imply a stronger economic recovery than I am currently anticipating and that would be good news.

Fixed interest markets have become popular investment vehicles in a very uncertain and risky equity environment over the past couple of years. So in an environment of strong demand and limited supply bond yields have been pulled down to historically low levels. 5-year rates currently stand at 3.25 per cent in the euro area, 2.74 per cent in the US and 3.92 per cent in the UK. 10-year rates in the euro zone currently stand at 4.08 per cent, in the US 3.85 per cent and 4.28 per cent in the UK.

It is possible that these rates could fall marginally in the very near term, but the downside potential looks extremely limited. The likelihood is that over the coming months long-term rates will start to gradually rise from current levels due to economic recovery being anticipated by the markets, slightly higher inflation expectations, and increased supply of government paper as budget deficits widen.

Bonds do not look good value relative to equities at the moment. For borrowers, the current level of long-term interest rates is very close to as low as they are likely to go in all markets, so the risk averse should now definitely consider fixing, if they have not already done so. Over the time period under consideration longer-term rates should have upside potential of about 200 basis points. As everybody should realise, forecasting interest rates is not an exact science, and so when rates fall to the low levels that currently persist, it is worthwhile taking out insurance against some unforeseen eventuality by locking in. Such insurances does enable one sleep more easily at night and that peace of mind is important.

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