Written by Liam O’Donnell of Artemis‘ fixed income team’s strategy on macro and rates
If there is one topic of interest to equity, bond, property and Multi-Asset investors alike at the moment it is… well, interest. More specifically, interest rates, says Artemis’ Liam O’Donnell as he reminds us of lessons from history and why guessing interest rates is a mug’s game.
Markets try to read the runes, anticipating moves by central bankers. But how good are they at it? Sometimes the best approach to forecasting is to look back at what’s happened before. I have been studying what’s currently priced into rates for the BoE today and trying to contextualise this against previous cutting cycles.
Lessons from the past
Going back to 1990, there are four clear cutting cycles – in 1990, 1998, 2001 and 2008 as shown in Chart 1. In all four, as you might expect, rates had plateaued immediately prior to the cut. As I write, the market is pricing in a 20bp UK rate cut in August and a 25bps cut in September. Assuming this happens, the policy rate will have been on hold for 12 months, as it was before the 1990 and 2001 cuts (actually, in the 2001 cycle the hold lasted 13 months. In 1998 it was just four months and in 2008 five).
But it is what happened next that is interesting. In all four cycles the rates dropped quite sharply over the next two years. The length of the plateau and the depth of the fall are uncorrelated, so don’t expect a sudden, sharp drop just because we’ve been hanging high for a long time.
Chart 1
If we look at what’s priced now vs. easing in previous cycles, we can see just how shallow a path the market currently prices.
Take some time with this next chart – chart 2. You can compare what’s currently priced vs. what happened in previous cycles. Typically, rates moved down far more than what is priced in for this time round. Even the shallowest in 2001 was 2%. The market is currently expecting just (a little over 1%) in cuts.
Chart 2
So now we know that rates have been on hold for basically as long as they have before any rate cut cycle going back to the 1990s. Secondly, that when the BoE has previously cut rates, it has tended to go in harder than the market is expecting it to do this time.
The here and now
Which brings us to more questions. Might they do so this time round? Did markets expect those cuts then? This is where it gets really interesting. You might say “all cycles are different, and 2024 doesn’t look like 1990, or 2008”, which is fair. So, I thought I would look at the last four cutting cycles, studying what was priced in going into the meeting (in terms of cuts over 1yr and 2yrs). I then compared that to what was actually delivered. What you see is that the market has always underestimated the amount of cuts. On average the market has priced in a cut of just over 1% over a year vs the 2.75% cuts that followed.
Chart 3
Over two years they were even poorer at guessing what cuts were coming, expecting just over 1%. What followed on average was cuts of just over 3.5%. In 2001 the two-year fall was 2% – but the forecast was actually for rates to go up marginally!
What can we conclude from this? Guessing interest rates is a mug’s game! Markets are not very good at it. We can probably expect rates to come down further than the market is now pricing in.
Perhaps, too, that it is dangerous to shape a portfolio around a specific interest rate forecast. A balanced approach seems more appropriate.
About Liam O’ Donnell
Liam leads the Artemis fixed income team’s strategy on macro and rates. He joined Artemis in November 2023. He began his career as a risk and research analyst at Abbey Capital in 2005. In 2010 he joined Standard Life Investments as a risk manager before joining its rates team in 2012. He managed UK, European and global government bond mandates in addition to the abrdn Strategic Bond and AAA Income funds. From 2018 he was head of UK rates and from 2019 head of nominal rates. He has a degree in Theoretical Physics from Trinity College Dublin and is a CFA charterholder.
