GovernanceInterest RatesUS, UK treasurers set to benefit from better returns on short-term investments, with interest rate hikes expected next year

US, UK treasurers set to benefit from better returns on short-term investments, with interest rate hikes expected next year

Barring further economic headwinds, rising IR and QE tapering could finally lift ultra-low yields

Corporate treasuries in the US and UK could soon benefit from improved returns on their short-term investments, as historically low interest rates are expected to end in 2022.

Cash-rich treasurers who have recently taken a loss on excess liquidity due to negative rates on their ultra-short defensive positions may finally be set for a rebound, said Patrick Kunz, treasury, finance and risk consultant at Pecunia.

While “due to [coronavirus] uncertainty the investment horizon was very short,” the expected upward path in interest rates will improve the overall investment backdrop for treasuries in the two geographies.

Conversely, although increased pressure on increasing interest rates is being perceived in Europe as well, Kunz said he didn’t see any significant rate hike coming up in the near future for the 27-country bloc.

“Even with increasing inflation, the European Central Bank cannot increase interest rates fast and [can] only slowly step down on asset buying.”

Interest rates expectations

Many leading economic analysts predict that US and UK interest rates will rise sooner rather than later to contrast the rise in inflation prompted by strong post-lockdown economic activity.

“Moving forward, we should expect the first rise in interest rates from the Monetary Policy Committee (MPC) during the second half of 2022, with the market currently pricing for the first hike in June 2022,” said Jesús Cabra Guisasola, associate at Validus Risk Management.

“However, if the UK economy continues growing as expected with inflation above the two percent target, we could see justification for the BoE to act sooner.”

“It does now look like the monetary policy fist may tighten around interest rates earlier than the bank had previously forecast if the economy continues to rebound,” added Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.

Streeter noted that, although the CPI measure of UK inflation is forecast to hit four percent by the end of this year – well above the official two percent target – base rates have been held at an “ultra-low” level.

In the US, interest rates are also expected to start rising next year to combat rising inflation.

“We remain confident that the Fed will begin hiking interest rates before the end of 2022, with the economy continuing to close the output gap in the months ahead,” says Mark Dowding, CIO at BlueBay Asset Management, pointing out that US inflation is expected to stay well above the Fed’s two percent target for the next 12-18 months.

Last week, the Bank of England (BoE) left base rates unchanged at 0.1 percent and its quantitative easing (QE) programme untouched at £875bn. In the US the Federal funds rate remained at its current target range of 0-0.25 percent and the US Federal Open Market Committee (FOMC) maintained its bond buying programme at $120bn.

Tapering of Fed’s, BoE’s asset purchases could boost bond yields

Many analysts are, however, predicting that both central banks will soon start cutting back their huge bond-buying programmes – a move that would see bond yields tick higher from their current ultra-low levels.

“Looking ahead, BlueBay remains confident that the FOMC will announce a taper to purchases in the next few months.

However, he added, “while tapering could still be announced at the September FOMC meeting, it is possible this could be deferred due to ongoing uncertainty [from] the Delta coronavirus variant.”

Dowding added that the valuation of real bond yields, which are now at record lows, have been attracting attention given the improving growth backdrop.

“To put this in context, a 30-year bond with a real yield of two percent is guaranteed to deliver a return of half its value in real terms at its maturity,” he says.

He attributes the low yields to high bond demand, boosted by the large US QE programme, which is now out of balance with supply.

“When a market is distorted through the central bank’s own policies, this could be a dangerous path to tread,” he says. “In our opinion, once the distortionary effect of central-bank purchases starts to abate, then a correction could be well overdue.”

On the other side of the Atlantic, however, Streeter pointed out that the Bank of England’s recent assessment of its own QE programme contrasted with the stronger dissent being voiced by some US Fed policymakers.

“The fact that there was just one vote of opposition to maintaining QE at this level in the UK indicates that this course of inaction is unlikely to change in the short term unless there is a drastic change in the UK’s prospects,” she said.

She added that, despite the successful vaccine roll-out in the UK, the recent infection spike and ensuing ‘pingdemic’, which refers to the mounting number of people being notified by the National Healthcare System to self-isolate, has dragged down forecasts for UK economic growth to three percent in the third quarter.

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