Interest Rate Outlook: US Inflation Data Unlikely to Deter Fed from September Tapering
Invesco Fixed Income shares its views of rates around the world
US: May’s US inflation data surprised to the downside for the third month in a row. While we expect US growth to continue at a solid pace, inflation is likely to stay low for the next several months before moving higher in 2018. We do not expect the downside surprise in inflation to delay the beginning of the Federal Reserve (Fed) plan to begin reinvestment tapering in September. However, future inflation readings will be critical in determining when the Fed raises the federal funds rate again. If inflation stays low, this may not occur until the middle of 2018.
Europe: We remain negative on our outlook for core European fixed income as the European Central Bank (ECB) is now acknowledging the economic recovery taking place in the eurozone and that policy must be adjusted accordingly. We prefer to focus our short positions on the 10-year part of the yield curve. The fact that the ECB is ready to move despite a lack of wage inflation has caught the bond markets by surprise and could pressure long-held core bond positions.
China: The onshore Chinese government bond (CGB) yield curve inverted in May, as shorter-term bonds underperformed longer-term bonds amid tighter short-term liquidity conditions. However, this inversion reversed after the Ministry of Finance purchased one-year CGBs for the first time in June. We think this move sends an important signal about the government’s role in managing the CGB yield curve. As financial deleveraging continues, we expect broad credit growth to slow in the third quarter. This will likely have a negative impact on economic growth in the second half of this year. We believe short-term government yields may still be subject to interbank liquidity fluctuations, but we expect longer-term yields to be more stable and outperform in the second half of 2017.
Japan: The Japanese economy continues to experience growth in excess of its potential, driven primarily by a pickup in consumption, and unemployment has declined to 2.8%.1 Wages must continue to increase if this momentum is to be maintained going forward, and Prime Minister Abe will likely encourage this trend. The improvement in the Japanese economy has not gone unnoticed. The International Monetary Fund recently described Abenomics as a “success.” It did, however, warn against fiscal tightening and an exit from monetary easing. In terms of the latter, we expect the Bank of Japan to keep policy unchanged for the time being, although it will likely continue to quietly taper asset purchases should conditions allow.
UK: The UK general election outcome in June took everyone by surprise. What was expected to be a one-horse race turned into something much closer. So close that the Conservative Party lost its outright majority in Parliament and only maintained control by teaming up with the Democratic Unionist Party. Coalitions with such a slim majority have not traditionally fared very well in the UK, with many holding together for less than a year. If Prime Minister May is to buck this trend, she will need to compromise more than she has in the past, not only with opposition parties but also with her own members of Parliament. This could prove to be untenable, and a leadership challenge or another election this year cannot be ruled out. In the shorter term, we expect many of the pre-election manifesto pledges to be downplayed and for there to be a far more conciliatory approach toward Brexit discussions. These talks are likely to be fractious in the early stages, but we expect cool heads to prevail in the longer term with the UK agreeing to a softer Brexit at worst. The probability of the UK remaining in the EU is also likely to increase. We expect the Bank of England to keep interest rates on hold and for gilts to underperform US Treasuries in the near term.
Canada: In June, 10-year rates bounced off their lowest levels to 1.53%, as first-quarter growth came in somewhat above expectations.2 The Bank of Canada is reviewing its economic outlook ahead of the next policy meeting in July. They now appear to be somewhat less worried about issues like uncertain US trade policy and another substantial drop in oil prices. This optimism may prove to be premature, so we are watching their stance closely. We expect interest rates in Canada to rise from current levels.
Australia: The Reserve Bank of Australia (RBA) held its benchmark interest rate steady at 1.50% as expected at its June 6 meeting. The statement was rather upbeat about the economy’s prospects but conceded that first-quarter growth would be weak. The unemployment rate fell to 5.5% in May, which is a new cyclical low.3 The RBA continues to be concerned with the leverage-driven housing market. While this concern will likely keep the RBA from lowering interest rates, stubbornly low inflation should keep hikes off the table as well. We remain neutral on Australian interest rates because we believe the RBA will be on hold for the foreseeable future.
Rob Waldner, Chief Strategist; James Ong, Senior Macro Strategist; Noelle Corum, Macro Analyst; Sean Connery, Portfolio Manager; Brian Schneider, Head of North American Rates; Scott Case, Portfolio Manager; Josef Portelli, Portfolio Manager; Ken Hu, CIO Asia Pacific; Yi Hu, Senior Credit Analyst; Alex Schwiersch, Portfolio Manager
1 Source: Ministry of Internal Affairs, May 29, 2017
2 Source: Bloomberg L.P., June 19, 2017
3 Source: ABS, June 15, 2017
Robert B. Waldner, Jr., CFA
Chief Strategist and Head of Multi-Sector
Rob Waldner is Chief Strategist and Head of Multi-Sector for Invesco Fixed Income (IFI). Mr. Waldner has overall management responsibility for the IFI public credit asset class teams and the Multi-Sector team. In this role, he is responsible for oversight of the portfolio construction process for IFI’s public security portfolios. Mr. Waldner chairs the IFI Investment Strategy team and is responsible for oversight of the overall IFI investment process. He joined Invesco in 2013.
Prior to joining Invesco, Mr. Waldner worked with Franklin Templeton for 17 years. At Franklin Templeton, he was a senior strategist and senior portfolio manager. He was the lead manager for Franklin absolute return strategies, and a member of the Fixed Income Policy Committee. Mr. Waldner was instrumental in the launch of a number of new strategies on the Franklin Templeton fixed income platform. Previously, Mr. Waldner was a member of the Macro team at Omega Advisors and a portfolio manager with Glaxo (Bermuda) Ltd. He entered the industry in 1986.
Mr. Waldner earned a BSE degree in civil engineering from Princeton University, graduating magna cum laude in 1986. He is a CFA charterholder.
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The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity.
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Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
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