The world’s central banks are increasingly taking different paths. This policy divergence presents an opportunity for active bond managers, particularly in short-dated bonds.
After keeping markets in suspense for most of the summer, the US Federal Reserve finally leapt into action in September, making a bold, 50-basis-point rate cut. This was an important statement; rates are coming down and bond yields should follow.
The Fed, however, has not been the only central bank to have made big moves in recent weeks. We’ve also had a 50-basis-point cut from the Reserve Bank of New Zealand and there’s good reason to believe (based on its statements) that another 50-basis-point cut will follow in November. In contrast, central banks in Norway and Australia have retained a hawkish bias, while the Bank of England seems to be cautiously following the gradual easing bias of the European Central Bank.
The differing messages coming from the world’s major central banks – and their ongoing policy divergences – are summarised below. The overall picture is that… there is no overall picture. For rates specialists like me, that means things are starting to get interesting.
A summary of recent central bank decisions
| Country | Current rate | Last decision | Communication tone | Comments |
| US | 4.875% | Cut | Dovish | It was a powerful statement from the Fed to cut by 50bps when growth is tracking 2.5% and the most recent inflation reading showed a bounce in shelter inflation. Powell was quick to point out that "nobody should look at 50bps and say this is the new pace" the reality is, if conditions are weaker, it is the new pace, or at least that's how the market sees it. |
| Canada | 4.25% | Cut | Dovish | The Canadian central bank continues on its dovish path, cutting rates for the third consecutive time. Inflation has been considerably weaker in Canada than the US. Governor Macklem recently spoke about the possibility of making 50 basis-point cuts should growth deteriorate further. |
| UK | 5% | Hold | Hawkish | An 8-1 vote for 'no change' at the September meeting of the MPC, with fresh guidance that, "in the absence of material developments, a gradual approach to removing policy restraint remains appropriate". This is a gentle signal that the market should not place the Bank in the same camp as the Fed, but it will realise that standing out too far from the crowd is a risky strategy. |
| Eurozone | 3.5% | Cut | Balanced | Having paused at their July meeting, the ECB cut rates by 0.25% and maintained its relatively cautious guidance on the future path for rates. Markets continue to price cuts at a more measured pace, with current pricing suggesting another "hold" at its October meeting. |
| Japan | 0.25% | Hold | Dovish | Governor Ueda pushed back against market expectations that rate hikes were guaranteed. With other central banks now firmly in easing mode, the pressure on the yen is easing, giving the Bank of Japan time to ponder its next move. The market continues to expect further hikes, which we also see as likely given domestic wage and consumption patterns. |
| Switzerland | 1% | Cut | Dovish | That the Swiss National Bank (SNB) cut rates for the second time came as a slightly dovish surprise; the market was only about 65% priced for a cut. A less dramatic shift in inflation forecasts compared to last time suggests the SNB is now less worried about inflation undershooting. |
| Sweden | 3.25% | Cut | Dovish | The Riksbank cut rates with increased dovish guidance. This brought its forecast policy rate into line with market pricing, which had moved significantly following weaker wage and inflation readings. Policy rates are now priced to fall below 2% by the end of next year. |
| Norway | 4.5% | Hold | Hawkish | The Norges Bank remains hawkish despite GDP and CPI (ex-energy) forecasts for 2025 having been revised lower (by 0.2% and 0.4% respectively). The currency was again the main focus. It is now clear that the Norges Bank is worried about any further depreciation in the krona. It forecast that rates will remain on hold at 4.5% for the rest of 2024. |
| Australia | 4.35% | Hold | Hawkish | No significant change to previous communication from the RBA. At the margin, however, it was more hawkish relative to its previous commentary (something the market largely ignored). |
| New Zealand | 4.75% | Cut | Dovish | A bold 50-basis-point cut with a significant pivot in the outlook, suggesting that policy is still restrictive even after the move. Market pricing moved swiftly. Most commentators now expect a further 50-basis-point cut in November and a quick return towards a more 'neutral' policy rate in the 3 -3.5% range. |
A fascinating setup for bond markets
The overall trend is towards lower rates, making this is a good time to own bonds. The post-pandemic experiences of the world’s major economies have, however, been quite different. The result is that monetary policy across the world’s currency blocs is increasingly falling out of step.
- The Bank of Japan is still discussing whether it may need to push rates higher.
- The Bank of England and the European Central Bank are suggesting their policy will be one of gradualism.
- The Reserve Bank of New Zealand and the Bank of Canada are discussing the possibility of cutting rates more aggressively.
Despite these clear divergences, investors currently seem to be pricing in relatively uniform rate-cutting cycles. This lack of discrimination creates opportunities for active bond investors with the tools and expertise to be active in the global rates market: we can exploit pockets of relative value that are being created by a desynchronised global rate-cutting cycle using cross-market trades.
The prospect of a steeper yield curve underlines the attractions of short-dated bonds
Clearly, in addition to deciding where to invest your capital you need to decide how much interest-rate risk to take. Making the right call on duration is important. And I would argue this might not be the time to uncritically add as much interest-rate risk to your bond portfolio as you can. How much confidence can you have in your interest-rate forecasts?
There’s simply no need to make your portfolio a one-trick pony when real yields towards the short end of the curve are as attractive as they are today. You’re getting a similar yield to the yield on longer-dated bonds – but with almost none of the interest-rate risk and lower volatility.
My central expectation is that the Fed will cut rates by another 50 basis points if the jobs market doesn’t show signs of recovery. That leads me to believe anything in the US yielding more than 3% with up to five years to maturity is currently a ‘buy’. And, while I do think there are risks to the upside for yields in the US, I see these risks as being concentrated towards the longer end of the yield curve.
