The outlook for global interest rates is very much dependent on the US economic outlook. Annual grow...
The outlook for global interest rates is very much dependent on the US economic outlook. Annual growth in the world's largest economy has deteriorated from around 3% to something close to 2% as residential construction has slowed very sharply.
As we know, this has extended to concerns over mortgage quality and is something we must monitor very carefully. Some commentators have suggested that this could prompt a wider financial shock.
For the moment, it is clear to us that the slowdown in growth comes at a time when US inflation is probably close to a peak. As a result, US nominal GDP growth will have been below the Federal Funds rate for around nine months. Historically, this has been a good indicator that it is probable that the Federal Reserve Board's Open Market Committee will start to cut interest rates.
We know that rate-setting officials remain concerned about inflation. However, the fact that, in its latest set of policy minutes, the Federal Reserve retreated from a commitment to tighten monetary policy and discussed the concept of policy "adjustment" going forward, strongly suggests that they have taken the first tentative steps towards lowering interest rates.
Meanwhile, all is not doom and gloom as healthy corporate profitability is sustaining historically narrow risk premia for corporate bonds in relation to sovereign debt. And emerging bond market fundamentals remain solid with countries like Brazil and Russia benefiting tremendously from the surge in primary product prices.
Turning our attention to Europe, the European Central Bank (ECB) has been vindicated in its decision to continue to raise interest rates as labour markets in France and Germany have improved markedly in the past few years. This points to a period of more sustainable growth in core European countries. However, the property boom seen in certain peripheral eurozone countries, such as Spain and Ireland, looks to have run its course and this might mean the ECB will start to contemplate a more neutral monetary policy stance going forward.
The euro has also been performing well, which is helping to contain inflationary pressures. Ten-year Bunds are yielding more than 4% and historically this has proved to be an attractive level for European institutional fixed income investors. Indeed, we think that there is a good chance that the ECB will not raise cash rates above 4%.
In summary, government bonds should start to look through the current peak in inflation, particularly in the US. Against this background, investors should achieve reasonable returns from government bond markets and can continue to benefit from the positive fundamentals underpinning lower quality debt.
Federal Reserve likely to start cutting interest rates
Emerging bond market fundamentals remain solid
Sustainable growth in core European countries as a result of rising interest rates
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