Interest Rate Outlook: Long-Term US Rates Could Rise on Global Growth and Stabilizing Inflation
Invesco Fixed Income shares its views on rates around the world
Inflation data continue to surprise to the downside. While this does not mean a December rate hike is off the table, continued weakness could cause the US Federal Reserve (Fed) to question its forecasts. Nevertheless, the Fed remains on track to begin its tapering of reinvestments in September, and we expect inflation to show signs of stability in late 2017. This inflation backdrop, together with robust global growth, will likely pressure US yields higher as term premium becomes priced in.
As growth in the European Union continues to gain momentum and broaden, a move away from ultra-loose monetary policy seems inevitable. We expect the European Central Bank’s (ECB) transition from its current unconventional policies into tightening mode to be very gradual and cautious. The goal will be to minimize market disruption while monitoring the future path of inflation (which remains well below the 2% ECB target), financial conditions and global growth. We think the ECB will reassess its monetary policy and announce further tapering of asset purchases in October (with a reduction from €60 billion to €40 billion initially) that will take effect in January.
The central bank maintained relatively tight liquidity conditions in the interbank market in August. Liquidity conditions could tighten further in September given quarter-end effects, and smaller financial institutions could face funding strains, although liquidity conditions for large banks should remain stable. In the medium term, we continue to see room for interest rates to decline, as tighter financial regulations and strengthened financial deleveraging efforts following the National Financial Work Conference are expected to reduce risk appetite and slow broader credit growth.
Japan just announced its sixth consecutive quarter of growth, the longest unbroken streak in over a decade. What is most impressive is that growth was broad-based and not reliant upon a temporary boost in inventories. More importantly, the consumer continues to play a major part. It is not clear what changed the consumer mindset, but a mild pickup in wages and a rise in full-time employment likely played a part. Looking ahead, we think the Bank of Japan will keep monetary policy unchanged, although a change in stance cannot be ruled out if other global central banks tighten. We expect 10-year Japanese Government Bond yields to remain range bound (0-0.1%) in the near term.
Economic growth forecasts for the rest of 2017 may be too pessimistic. Many are based on the consumer making less of a contribution than in the past; household savings are at a record low, real wages are negative and property price increases are slowing. But recent data suggest that a slowdown may take longer to play out. The household savings ratio understates the amount that consumers have put away for a “rainy day,” employment is holding up, inflation is expected to decline and home prices are steady so far. A weaker sterling is also helping exports and the UK government will likely continue to try to demonstrate that it will not allow the economy to fall off a cliff (over Brexit), meaning there is a chance for a positive growth surprise. Brexit discussions could become factious over the coming months, however, and we expect the Bank of England to keep monetary policy unchanged through year-end.
The Bank of Canada has moved firmly into the hawkish camp, leaving the market expecting another rate hike at the October meeting. The benchmark rate was raised to 0.75% in July.1 Recent economic data continue to surprise to both the upside and downside. Canadian GDP growth leads the developed world at 4.6% year-over-year (as of May), while inflation remains low at 1.2% year-over-year.2 The 10-year Canadian government bond yield topped out at 2.05% at the end of July, and then promptly turned lower.3 We believe that risk remains for higher rates in the future.
The Reserve Bank of Australia (RBA) held its benchmark interest rate steady at 1.50% as expected at the August meeting.4 Annual inflation remains below the RBA’s target band and the unemployment rate remains elevated at 5.6%.5 The housing market remains robust, and that, combined with low inflation, stubborn unemployment and sluggish wage growth, should keep the RBA on hold for the foreseeable future. We remain neutral on Australian interest rates.
Rob Waldner, Chief Strategist; James Ong, Senior Macro Strategist; Sean Connery, Portfolio Manager; Brian Schneider, Head of North American Rates; Scott Case, Portfolio Manager; Josef Portelli, Portfolio Manager; Yi Hu, Senior Credit Analyst; Ken Hu, CIO Asia Pacific; and Alex Schwiersch, Portfolio Manager
1 Source: Bank of Canada, July 12, 2017
2 Source: Statistics Canada, GDP: July 28, 2017, Inflation: Aug. 18, 2017
3 Source: Bloomberg L.P., July 31, 2017
4 Source: Reserve Bank of Australia, Aug. 1, 2017
5 Source: Australian Bureau of Statistics, Aug.16, 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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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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Interest rate outlook: Long-term US rates could rise on global growth and stabilizing inflation by Invesco