Time to hedge your interest rate risks?

Last week the renowned IHS Markit pleaded for a rate hike in the eurozone. The analytics company’s monthly European purchasing managers’ index (PMI) signals that the number of ‘bottlenecks’ which could create price increases are rapidly increasing. Past experience demonstrates that the index has an important predictive value and usually provides a reliable impression of the state of the economy.

In the past, a value of 54 often proved to be the threshold for an increase in interest rates. This score indicates a moderate increase in activities. If the index were to go up more, interest rates could increase further as well. The latest Markit data show that the Eurozone Manufacturing PMI reached the level of 60.1 in November. It is the second highest reading ever, exceeded only by a record high reached in April of 2000.

ECB

In the current upbeat economic climate you would be forgiven to think that the ECB is about to raise its main interest rates. However, the ECB has not yet reached this point. This is understandable because if the ECB were to convey this message, interest rates in the eurozone would immediately go up. Southern European countries such as Spain and Italy certainly cannot bear higher interest rates yet. After all, the current economic growth would first have to persist.

The problem with this ECB policy is that if inflation were indeed to rise before too long more than has been foreseen, interest markets would immediately start taking into account higher interest rates in the future. In this case, interest rates would have to go up (far) more quickly than if the ECB were to hike its rates at this point.

Futures

If we look at three-month Euribor futures (i.e. the interest rate at which the Euribor rate can be fixed for that future date), we see that the market currently only takes into account an increase of 1 percentage point in the Euribor rate for the coming 4.5 years (as of June 2022).

Euribor Jan 2018 -/-0,32%
Euribor Dec 2018 -/-0,27%
Euribor Dec 2019 -/-0,05%
Euribor Dec 2020 0,30%
Euribor Dec 2021 0,57%
Euribor Jun 2022 0,70%

 
If the PMI is giving off the right signal now, this will come down to a distinctly higher level of interest rates in the years ahead, all the more so because US interest rates will probably continue to rise, with European interest rates usually being pulled up somewhat by the suction effect.

Benefit from low swap rates?

If you are considering hedging (part of) your interest risk, you will soon be too late for the really good rates. 5- and 10-year rates are still available at a very appealing price, but we believe this will not be the case for much longer.

Make sure you are not taken by surprise due to an unexpectedly rapid rise in interest rates, and fix the current low interest levels for the years ahead. ICC can support you in selecting the interest rate instrument that is the most appropriate for you, and ensure you do not overpay. Margins on interest rate swaps (IRS) and interest rate caps are relatively high and can be negotiated.

Request our white paper on bank margins in interest swaps.

If you are following medium term interest rate developments request access to our research platform. You will have access to clear and unbiased analyses on interest rates, EUR/USD, EUR/GBP, macro economic developments and political risks.

For more information on ICC Consultants click here.

Should you have any further questions, please contact us at icc@icc-consultants.nl or +31 30 820 1221.

Arian Ververs
Arian Ververs
Managing Director