Easing into Autumn: Rate cuts, volatility and valuations

During our recent LSEG webinar held in October, LSEG Pricing Service subject matter experts discussed the impact that slowing inflation, current monetary policy stances from the leading central banks, low economic growth and other factors are having on bond markets around the world. Volatility in debt securities valuations is becoming more common, driven by the global and local challenges. In such an unpredictable environment, it is more important than ever to have a trusted source of evaluated pricing.

• While key themes such as inflation and economic growth are impacting most countries, individual markets are exhibiting a diverse set of reactions to this, creating volatility in all asset classes.
• Certain geopolitical risks are also a factor in driving current volatility.
• In such an environment, global firms are increasingly using LSEG Pricing Service to ensure timely, relevant, accurate and fair value data is incorporated in their portfolio management needs.

“Predictable volatility” – the idea that the unpredictable nature of the financial markets is now predictable as risk events seem to be occurring more frequently – was the focus of a recent speech by Nikhil Rathi, CEO of the UK Financial Conduct Authority. The discussion highlighted the rising volatility in various debt securities markets, a trend emphasized during a recent webinar by LSEG. Speakers explored the global drivers of market instability, such as interest rate cuts and examined how this heighten volatility is affecting debt market evaluated pricing. An evaluated price is derived for a debt security using a market-based calculation methodology and relevant data to estimate the security’s value at a given time.

Volatility in individual debt markets seems to be driven by specific issues that each individual country faces in coping with the current global economic situation. For example:

• European bonds – Weak European growth is led by Germany; it is possible that the country will contract for the second year in a row in 2024 – underscoring overall sub-par business activity. In response to the overall sluggish outlook, the European Central Bank (ECB) trimmed rates again in October, and further cuts are expected. Unsurprisingly, demand for fixed income new issues remains strong, with a good uptake from asset managers. Nonetheless, the ECB remains concerned that inflation could come back and cause potential price volatility in the market.
• UK bonds – The bond markets are watching the new UK government’s activity carefully to see what the future holds for public spending. The recent Budget announcement saw a move upwards in yields with UK government’s debt-to-GDP ratio at around 100%. The markets are very sensitive to any risk of large public sector spending programmes that are not adequately financed.
• US bonds – The next few weeks are likely to witness some volatility in the US bond markets. The 50bp rate cut in September by the Federal Reserve was followed by another cut delivered after the November election because of an uncertain outlook for jobs growth/inflation outlook. The election has delivered some volatility across bond and equity markets – as may the 1 January 2025 deadline for lawmakers to raise the nation’s debt ceiling or risk defaulting on more than $35 trillion in federal government debt.
• Japanese bonds – The potential normalisation of Japanese interest rates, with gentle rate rises flagged by policymakers, could have significant knock-on effects for the economy and both government and corporate debt. Higher interest rates could drive appreciation in the yen, which could create headwinds for the export sector. Already the Nikkei stock market was more volatile this year because of these trends, and further volatility in bond trading may also ensue.

In summary, current international issues such as inflation and weak economic growth are playing out differently and varies per country, generating either volatility today or potential for volatility tomorrow.

In addition to factors specific to individual countries, the uncertain geopolitical outlook with wars in both the Ukraine and the Middle East is impacting debt markets. However, individual debt markets seem to have factored in a certain amount of this risk. In the Middle East for example, the Israeli debt markets have remained stable since the hostilities began on 7 October 2023, even in the face of a recent ratings downgrade to Israeli debt. Nonetheless, the broadening of the Israeli regional conflict could drive a spike in oil and other commodity prices if supply chains are disrupted, potentially rekindling inflation around the world.

Other risks to the outlook for debt securities include changes in consumer spending patterns.  The shift towards internet shopping and working from home has negatively hit commercial real estate securitised debt, for both office buildings and shopping malls – both in Europe and in the US. There are concerns among some analysts that the weaknesses in the commercial real estate market could spark the same kind of devastating correction that contributed to the cause of the financial crisis of 2007-2008, in the residential mortgage securitisation markets back then.

In summary, investors in debt markets need to be prepared to encounter volatility and ensure they have a trusted source of pricing data for valuations of their portfolios. Top quality pricing across all asset classes, geographies and events means that our clients, regulators and other stakeholders have full confidence in the valuations of their assets.