Rufaro Chiriseri, director and head of fixed income for the British Isles at RBC Wealth Management, discusses the firm's portfolio positioning in fixed income, explaining why it is underweight in credit in the UK and Europe and neutral in gilts.

Rufaro Chiriseri at Canada-headquartered RBC Wealth Management believes it is likely that the European Central Bank (ECB) is at the end of the hiking cycle for interest rates.

She expects the deposit rate to remain at 4 per cent, with markets now only pricing a cumulative 5 basis points worth of hikes for the rest of the year.

According to the September ECB staff projections, growth is projected to stagnate in the third quarter of 2023 and remain subdued in the fourth quarter. Chiriseri believes that the ECB now perceives that current interest rates are consistent with meeting its inflation goal.

According to flash estimates from the EU statistics agency Eurostat, eurozone inflation dropped to 4.3 per cent in September from 5.2 per cent in August – its lowest level since 2021. The figures suggest that efforts to curb inflation in the zone are paying off. See more here. 

The ECB has also lowered its inflation estimate for 2025, stating that interest rates have reached levels which, if maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. Yet ECB voting members have been noncommittal on whether this marks the “plateau” for interest rates. Maintaining hiking optionality is pragmatic for the central bank, in Chiriseri’s view, as there are still risks of upside surprises in inflation data.

She sees compelling opportunities in government bonds as yields are close to peak levels. Current market pricing indicates a soft landing economic scenario. However, as she expects growth to disappoint, Chiriseri is biased towards adding to sovereign positions and duration.

Corporate spreads have tightened year to date, but she is loath to chase this rally as higher financing costs are impairing corporate fundamentals. Chiriseri remains cautious and maintains her underweight in European credit, with a preference for investment-grade over high-yield credit.

United Kingdom
For the UK, Chiriseri’s base case is that the Bank of England (BoE) will maintain the bank rate at 5.25 per cent, marking the terminal rate for this hiking cycle. “Future inflation data could present a risk to that view. According to the latest BoE guidance, additional hikes may be warranted if there are more persistent inflation pressures,” she said. RBC is forecasting inflation at 4.9 per cent by year-end. A higher number may force the BoE’s hand, and with inflation so far off the 2 per cent target, she does not expect rate cuts until next year.

The central bank has also stepped up the pace of its balance sheet reduction in a process known as quantitative tightening (QT) to £100 billion ($122 billion) from £80 billion. “The £100 billion total is dominated by an increase in gilts maturing, with the balance from gilt sales over the next 12 months. The increase in long-end gilt supply has been well flagged and yields have trended higher,” Chiriseri said. She maintains a neutral position in gilts given the recent rally, and she sees the August peak levels as attractive entry points to increase allocations. 

“Similar to Europe, corporate fundamentals have deteriorated due to tighter financing conditions. Moreover, spreads have narrowed as a result of no further active BoE corporate bond sales as part of the quantitative tightening process,” she continued. While yields are near five-year highs, the compensation for risk present in current spreads is at historical averages. Chiriseri therefore prefers to remain underweight in credit as she thinks sterling corporate spreads have further room to widen, leading to potential underperformance.