2023 was a year of major fluctuations in the fixed income market, what is the outlook for 2024? Interest rates were affected by market turmoil at the start of the year, but stronger than expected macro data in the middle of the year contributed to the perception that we are heading for a very soft landing for the economies, which led to a relatively sharp rise in longer-term interest rates in particular.
Particularly strong rise in interest rates in Norway
The rise in interest rates was particularly strong in Norway in the first half of the year, as inflation showed few signs of coming down and the krone exchange rate weakened sharply.
Since mid-October, we have seen a significant decline in interest rates based on increased expectations of interest rate cuts in 2024. In 2023, the rate hikes did not come as much of a surprise to the market as in 2022. Both the Federal Reserve and the ECB have raised interest rates somewhat more than expected at the start of the year, but the difference between expectations and outcomes is not dramatically large.
The main exception is Norway, where a slow decline in inflation and a weakening krone have led to significantly larger interest rate hikes than expected at the start of the year.
Biggest surprise in Europe and the US
For the US and Europe, the biggest surprise in 2023 has been that the real economy has held up better than expected, and for much of the year the market has priced in increasingly lower expectations for interest rate cuts in 2024 and 2025.
This resulted in a significant increase in interest rates with longer maturities from May to November, with a preliminary peak for US 10-year interest rates of over 5 per cent around mid-October. At the same time, we have seen a positive development with falling inflation in both Europe and the US, and gradually also in Norway, although developments here at home are still lagging behind.
The fall in interest rates in the latter part of 2023 seems to be based on an increased degree of certainty that the central banks are now at the peak of their key interest rates and that we will see interest rate cuts through 2024.
Weaker indications from the real economy
The US and European economies, including Norway, are showing somewhat weaker indications from the real economies, and inflation continues to fall.
Significant interest rate cuts are now expected from most central banks in the coming years.
As we see the picture now, the market is pricing in a continued slowdown in the economies and a continued movement in inflation towards the inflation target, i.e. a soft landing.
The pricing in the interest rate market indicates that the central banks may move from a relatively strong tightening monetary policy to a somewhat less restrictive policy through 2024.
Upside and downside risk
We are by no means at a point where the market is pricing in a severe economic downturn. If the market's current expectations should materialise, which they rarely do, we will most likely still have key interest rates that have a tightening effect on the economies at the end of 2024.
On the upside, there is a risk that real economies will reaccelerate or that the decline in inflation will come to a halt. On the downside, there is a risk that the economic downturn will be greater than currently expected. Overall, we still believe that bond yields represent good value, although the recent rapid fall in interest rates entails a risk of a rebound.
Credit margins increased significantly through 2022, which means that bonds with credit risk provided relatively weak returns against a headwind.
In 2023, the picture has been more mixed, credit margins for most sectors and companies have recovered somewhat, but are still at significantly higher levels than at the start of 2022.
However, there is one sector that has ended up in the credit market's spotlight: For most companies in the real estate sector, we have seen a continued decline in credit margins, although here too the picture has improved somewhat with the recent fall in interest rates, and for solid property companies the margins are now lower than at the start of 2023. "The credit margin exit in 2022 and relatively stable margins in 2023 mean that credit margins are still at usable levels, which should provide a good starting point for 2024.