15 March 2024

Since late last year, European and US investors have anticipated interest rate cuts, driven by widespread concerns about potential economic weakness. However, despite falling inflation concerns, central banks and their chief economists have chosen to maintain a cautious stance, opting to keep interest rates steady.

Key takeaways

• Central banks remain cautious on interest rates cuts
• Pessimism about long-term economic prospects has resulted in an inverse yield curve
• Front-end yields are relatively competitive vs longer-dated strategies
• In this environment, ultrashort bond funds present a compelling investment opportunity

Recent statements and actions from key central banks underscore their prevailing caution in response to economic uncertainties. On 7 March 2024, the European Central Bank (ECB), decided to maintain its key interest rates steady, citing insufficient confidence to initiate monetary easing. ECB President Christine Lagarde highlighted persistent economic challenges, including subdued consumer spending and declining exports. Similarly, in the UK, Bank of England Chief Economist, Huw Pill, emphasised the need for compelling evidence before considering a rate cut.

Market response

Uncertainty among investors has arisen from consecutive quarters of mixed economic signals. Inflation rates are falling faster than expected across most regions, amid unwinding supply-side issues and the implementation of restrictive monetary policy. Meanwhile, risks to global growth remain, resulting in a cautious approach by central banks.

Insights from the International Monetary Fund (IMF) provide context to the challenges confronting central banks and investors. Global headline inflation is expected to fall to 5.8% in 2024 and 4.4% in 2025, with the 2025 forecast revised down.  The IMF’s forecast for global growth in 2024 and 2025 projects resilience, with a 0.2 percentage point increase in 2024 from the October 2023 World Economic Outlook.

Investor strategies for uncertain markets

Investor pessimism about long-term economic prospects has resulted in an inverted yield curve, indicative of expectations of an economic slowdown or recession. Historically, an inverted yield curve has been one of the most reliable predictors of an upcoming recession. The inversion suggests that investors expect future interest rates to fall as central banks lower rates to stimulate a slowing economy. It indicates a lack of confidence in the economic outlook, as investors are willing to accept lower yields for long-term bonds in anticipation of even lower rates in the future. This means front-end yields are relatively competitive when compared to longer-dated strategies. As a result, ultrashort corporate bond strategies (with maturities below one year) present a compelling alternative to traditional money market instruments and short term government bills in the current environment. These strategies typically exhibit low historical volatility, as well as minimal interest rate and spread risk.

Sources: IMF World Economic Outlook update (January 2024), Bank of England Monetary Policy Strategy remark (March 1, 2024), ECB Monetary Policy decision (March 7, 2024).