Investors downgrade expectations of global interest rates rise after banking turmoil

Investors lowered their expectations of rising global interest rates after the turmoil in the banking sector, while market indicators indicate that the period of rapid growth has come to an end.

The pricing of derivative products such as interest rate swaps indicates that investors believe that many of the world’s major central banks will not raise rates further, and in some cases will start cutting rates before the end of the year.

“Global interest rates are nearing a peak,” said Mark Zandi, chief economist at Moody’s Analytics. “Suddenly, the fragile global banking system is putting pressure on central banks to stop raising rates as early as possible.”

Now the swap rates suggest that the US Federal Reserve, the Bank of Japan and seven other major central banks are now expected to keep rates at their next meetings. Markets are divided over whether the Bank of England and the European Central Bank will raise rates in May, after assessing the high likelihood of an increase in early March.

“We’ve had one of the most aggressive rate hike cycles in decades, followed by bank turmoil, and now peak rates are firmly on the horizon,” said Suzanne Streeter, senior investment analyst at wealth manager Hargreaves Lansdown.

The reassessment comes after one of the most dramatic tightening cycles in recent history. Over the past six months, the 18 largest central banks have raised rates by a total of 16.45 percentage points.

Just two weeks ago, the peak of world interest rates seemed far away.

In early March, investors expected the target range for federal funds rates to rise to 5.5-5.75% by December from the current range of 4.75-5%. Changing Derivatives Price Signals markets are now waiting by then, the range will be about 4 percent.

Earlier this month, investors expected the European Central Bank’s deposit rate to reach 4 percent by the end of the year, up from the current 3 percent. They now expect the deposit rate to be 3 percent by then. Interest rate expectations for the Bank of England by the end of the year fell from about 4.75% at the beginning of March to about 4.25% as of Monday.

Line chart of key interest rate expectations across six policy meetings, based on derivatives market pricing, showing that market rate expectations have changed radically since the banking turmoil began

“Major central banks, including the Fed and the ECB, should make a joint statement that any further rate hikes are out of the question, at least until financial markets return to stability,” said Eric Nielsen, chief economic Advisor to UniCredit Bank.

Last week, the Fed, the Bank of England and the Norwegian central bank raised rates by a quarter of a percentage point. The Swiss National Bank advanced half a point despite the takeover of Credit Suisse by rival UBS, and the ECB did the same last week.

However, policymakers at most of these banks have signaled that further increases in borrowing costs depend on the easing of shocks in the banking system.

“You can think of [the turmoil] as the equivalent of a rate hike or perhaps something more,” Fed Chairman Jay Powell said last Wednesday, signaling that panic could be doing the job of setting rates for them.

“Because of stressful conditions, banks have become less willing to lend and they will often lend by raising interest rates,” said Kostas Milas, a professor at the University of Liverpool.

UBS predicts that more than half of the 32 central banks it monitors will cut interest rates by the end of 2023. Seven more will leave them unchanged.

However, some economists remain concerned that high inflation will force creditors to keep raising rates.

Zandi said signs that inflation will prove sustainable could mean that central banks “sacrifice their economies to get inflation back on track.”

Data on inflation in the US and the euro area should be published on Friday.

3-month moving sum bar chart showing the number of increases and decreases in interest rates among 18 major central banks.

Some interest rates in Latin America and Eastern Europe kept interest rates at the same level for several months.

“Emerging market central banks were among the first to respond to rising inflation and rate hikes, and may still be the first to start a cycle of rate cuts,” Streeter said.

The interest rate swap market is one of the largest derivatives markets in the world. The gross value of outstanding interest rate derivatives rose significantly over the first half of 2022 in response to rate hikes by central banks, according to Bank for International Settlements date.