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In mid-December, we closed the hedging for a major EUR refinancing by one of our clients at a mid-swap rate of just 0.09%. Had the timeline slipped to today, the borrower would have had to contend with a rate of 0.28% - a threefold increase.
Similarly, at the start of January, we traded a swap for a GBP financing off a mid-rate of 0.94%. Now, some three weeks later, the market rate is about 20 basis points higher.
Blink and you’ll miss it, but swap rates have been on the rise since the beginning of September last year. Five year USD swap rates are up from 1.71% to 2.55%; in GBP they went from 0.74% to 1.31% and in EUR we have seen five year rates climb from a level of 0.13% to 0.45%.
It is notable that the rise in swap rates commenced following the ECB press conference on 7 September 2017, when the ECB stopped talking the euro down and hinted that in light of an improving economic picture their emergency monetary policy will eventually come to an end, starting with a tapering of the central bank’s QE programme. It is also worth noting that the ECB meeting that set off the increase in swap rates took place only two weeks after the Jackson Hole gathering in August, and that in November, the Bank of England increased its benchmark rate from 0.25% to 0.50%. Make of this what you will, but it suggests that there were some conversations in Wyoming around better central bank coordination – which is another way of saying that the FED had complained to its European counterparts about their sticking to accommodative monetary policies whilst in the US it was all about normalisation.
Whether covertly coordinated or not, the fact of the matter is that the world economy is experiencing something which Davos folks might refer to as broad, globally synchronised growth. It is no longer just the US or China powering ahead. The economic picture in the Eurozone has been improving for a while now and the UK still hasn’t fallen off a cliff. Japan’s growth and inflation readings have also ticked up. As the economic picture has kept brightening up, central banks have become markedly more hawkish. The FED is looking to start unloading its balance sheet and the market is wondering whether there will be four instead of three rate increases this year. The BoE might hike rates three times before the end of 2019 and the ECB is guiding markets towards the end of QE and negative rates. There you have your recipe for higher swap rates.
One thing market observers have been wondering for a while now is how equities would react to higher rates. The sell-off in stocks seems to suggest that the answer is ‘not well’ and as equities dropped, swap rates have come down again a little. It is anyone’s guess whether stocks are now entering a correction, but assuming that the economic outlook stays the same, I don’t see central banks changing their stance. For rates to trend markedly lower again, I am afraid we may need another recession and I don’t think anyone is wishing for that.
The bottom line is that the synchronous tightening of major central banks indicates that the interest rate cycle has indeed turned. As it stands, the trajectory for interest rates is up, although the pace at which normalisation will occur is highly uncertain. While current forward curves appear somewhat optimistic, there is scope for inflation to overshoot which could accelerate tightening. In any case, the time – if there ever was any - to not worry about interest rate risk looks to be well and truly over.
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