The 50 basis points rise in US interest rates last month and some fairly encouraging data since are ...
The 50 basis points rise in US interest rates last month and some fairly encouraging data since are welcome but they will not necessarily engineer a soft landing.
Domestic consumption is not going to evaporate quickly and the recent labour stats may not indicate a trend reversal. Markets will be conditioned by virtually every bit of economic data that is released. There is some evidence to suggest that there will be a soft landing but it is still not a foregone conclusion and it will need at least one more hike in interest rates. The Fed may hold off in June but one or two minimum rises are on the cards.
In Europe the ECB has perhaps been more aggressive than was needed but the rate of EU growth is accelerating and it looks as if the euro has survived a flirtation with danger-laden technical levels.
All indications are that the single currency has bottomed. Further recovery against the dollar will depend on EU growth rates rising and US growth tailing off.
In the UK we are clearly near if not at the peak in the interest rate cycle, providing the slide in sterling does not become so precipitate that the Bank of England sees further inflationary dangers. A steady decline in the value of the currency is anticipated removing any need for knee-jerk reactions from the MPC. The latest RPI figures and the easing in average house prices show that inflation is still running well below target.
The long-end of the gilt market is best left out of the equation but the third quarter of the year should provide fair returns from the short-end. As in Europe, UK corporate bond spreads have been widening and even top-flight investment grade names are losing their shine as M&A activity affects the rating trends.
In Japan rates are likely to hold until deflationary threats disappear and the economic recovery gets under way. The signs are promising with exports going well, corporate earnings increasing and capital expenditure rising. Against this there is still no sign of domestic demand picking up. This suggests the Japan bond market is going nowhere.
If a soft landing in the US is achieved then burgeoning growth in Europe and real recovery in Japan will follow. A hard landing would hurt all bond markets in the short term.
Rod Davidson is head of the Murray Johnstone Economics and Fixed Income team
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