Investors have been betting on when interest rates will come down since mid-2023, when the US Federal Reserve first paused rates. The South African Reserve Bank and most other central banks followed.
Since then, financial markets have been much more optimistic than the central banks on when – and by how much – interest rates will decline.
This month we saw the Fed chair Jerome Powell make comments that could, at last, pave the way for interest rates to come down … Even if inflation doesn’t reach its target of 2% sustainably right now.
Light at the end of the tunnel for borrowers – and investors
The interest rate hikes central banks implemented over the past two years have been so aggressive that economists have consistently warned central bankers against overdoing it and running the risk of driving economies into recessions that would be exceptionally hard to turn around.
Financial markets have consistently been more optimistic than central banks about when interest rates are likely to come down, but the central banks have remained ultra-hawkish, determined to see a sustainable decline in inflation before reducing rates.
Recent inflation data hasn’t helped. Consumer price inflation came in higher-than-expected in the US and South Africa in February, moving inflation further away from the central banks’ targets and potentially pushing out the timeline for interest rate cuts. Markets have been pricing in three interest rate cuts this year, with the first being announced in June.
However, in recent weeks there have been signs that there is, indeed, some light at the end of the tunnel for borrowers and investors.
Evidence supporting interest rate declines
Most significant was Powell’s acknowledgement, in the wake of a surprise increase in US unemployment, that a deterioration in labour market conditions could prompt the Fed to lower rates. Other concerning signs are the rising consumer debt defaults and credit card delinquencies (people falling behind on their credit card payments) in both the US and South Africa.
Underpinning the argument in favour of reducing interest rates is the fact that inflation rates globally have come down considerably from their 2023 highs, even if they have ticked up recently in the US and SA.
Risks that we will be disappointed
Geopolitical tensions probably pose the greatest risks. Russian President Vladimir Putin’s recent warning that its nuclear forces are in “full readiness” and the possibility of Donald Trump, who has always taken a hardline defence stance, again becoming US President could increase inflation risks.
What it means for investors
With the US stock market having reached 20 successive all-time highs this year, more and more analysts are warning that equity valuations are beginning to look stretched. A lower interest rate environment would improve the macroeconomic fundamentals underpinning them.
Lower interest rates would also be a boon for bond market investors, with yields on government bonds declining in line with interest rates and prices rising.
Bottom line: The odds of interest rates coming down in the second half of the year improved in March … As long as inflation data doesn’t set off any further alarms and geopolitical conditions don’t deteriorate further.
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Disclaimer – *The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.
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