Higher forever? Markets see few rate cuts after 2024

However much they may fall in 2024, pricing in money markets highlights the view that the decade of near-zero interest rates that prevailed after the Great Depression is unlikely to return. financial crisisas long as inflationary pressures and public spending remain high.

That risks further pain for many public and private borrowers who clung to lower rates in the past and have yet to feel the full impact of record-paced rate hikes. central banks of the last two years.

In recent weeks, traders have redoubled their bets on sharp rate cuts next year, encouraged by slowing inflation and the moderate turn in the economy. Federal Reserve United States.

Expectations that rates will fall by at least 1.5 percentage points in the United States and Europe have boosted bond and equity markets.

But while the Federal Reserve is expected to cut its base rate to around 3.75% by the end of 2024, it will only drop to around 3% by the end of 2026, before rising again to around 3.5% thereafter. as suggested by money market prices.

This is in stark contrast to rates that remained near zero for most of the decade following the global financial crisis, only gradually rising to 2.25%-2.50% in 2018.

It is expected that the rates of European Central Bank will be around 2% at the end of 2026, from the current 4%, which represents a reduction, but hardly a sign of a return to the unorthodox experiment with negative rates that was seen from 2014 to 2022.

“It is simply about normalizing politics. “It is not entering into an easy monetary policy,” said Mike Riddell, senior portfolio manager at Allianz Global Investors.

These expectations are consistent with a scenario in which the so-called “neutral” interest rate, which neither stimulates nor slows economic growth, has risen since before the coronavirus pandemic. COVID-19according to economists.

The U.S. economy, which has so far avoided the recession many expected amid aggressive policy tightening, has also supported that argument.

Increased inflation risks from geopolitical tensions and offshoring, looser fiscal policy, and potential productivity gains from AI are some of the factors that may be raising the neutral rate, often called “R-star”.

Some notion of the neutral rate, although impossible to determine in real time, is key to understanding an economy’s growth potential and a central bank’s decision on how much to cut rates in the future.

Whether the neutral rate has moved is the subject of much debate and not everyone is convinced that it has risen.

Fundamentally, market expectations are higher than the 2.5% estimate of the Fed for long-term interest rates, although several policy makers have placed it above 3%.

In the euro zone, ECB policymakers aim for a neutral rate around 1.5%-2%.

“I am skeptical that there has been a big change in the R star,” said former Fed economist Idanna Appio, now a portfolio manager at First Eagle Investment Management.

Appio is baffled why markets are pricing in rates to remain high while many measures of inflation expectations suggest it should return to central banks’ targets. It is too early to talk about an increase in productivity, he added.

Gauging where rates will go in the coming years is not easy and markets can be wrong.

But their expectations justify the caution of borrowers, accustomed to and still benefiting from the low rates of recent years.

“It means that companies will need to refinance at rates reasonably and sometimes significantly higher than those they had on the books over the past five years,” said Patrick Saner, head of macro strategy at Swiss Re.

“In this context, the higher rate environment really matters quite a bit, especially when it comes to corporate planning.”