The US Federal Reserve continued with its ‘normalisation’ of monetary policy during the quarter with an interest rate rise of 0.25% in March; the sixth 0.25% hike since the end of 2015. The Fed upgraded its forecasts for economic growth, and projected a lower unemployment rate through 2020, as well forecasting that inflation would exceed its long-term inflation target of 2% in 2020 on a temporary basis.
As a result, it raised its forecasts for the future path of interest rates. In Jerome Powell’s first conference since taking over the Chair of the Federal Reserve, he avoided sending out an overtly hawkish signal about interest rate policy, sticking to prior forecasts of a further two rate rises this year.
However, the Fed did raise its projections from two rate hikes to three next year, and a total of eight between the start of 2018 and the end of 2020. If these forecasts are accurate, interest rates in the US will be over 3% by the end of 2020. This is where the Fed estimates the ‘neutral rate of interest’ to be at present; meaning neither expansionary nor contractionary.
Other central banks across the globe are now following the Fed’s lead in tightening monetary policy. Both the European Central Bank (ECB) and the Bank of Japan (BoJ) have become more optimistic on their respective economies in recent months without an explicit change in future policy.
The ECB is expected to revisit its communication stance as 2018 progresses, preparing the markets for an eventual end to its monetary stimulus programme. ECB President Mario Draghi has also come under pressure from a number of ECB officials to start raising interest rates in mid-2019. Meanwhile, despite the Bank of Japan’s official line that there has been no change in policy, the BoJ reduced its purchases of government bonds in January, prompting speculation that the central bank was scaling back its monetary stimulus programme. These fears proved unfounded but highlighted how sensitive the market is to any signal of tightening monetary conditions.
The Bank of England kept rates on hold at its latest meeting. However, there were two dissenting voices from the nine-strong Monetary Policy Committee, voting for an immediate hike and setting the stage for an interest rate rise at the May meeting. MPC member Gertjan Vlieghe went further, and suggested that the outlook warranted one or two 0.25% hikes per year over the next three years. He also added the caveat that there was “significant uncertainty about the path of rates”, and these forecast would be dependent on how the economy evolved.
China named its new Governor of the People’s Bank of China in March. Yi Gang had been a Deputy Governor since 2008, and is the first new central bank Chief in fifteen years. The US-educated former economist is widely viewed as a reformer, and is therefore expected to continue with further financial market reform measures. The Chinese government has recently approved measures to combine its banking and insurance regulators, with some of their policymaking responsibilities ceded to the central bank.
The yield on the US ten-year Treasury bond rose steadily from around 2.4% at the beginning of the year, to a peak of around 2.9% in mid-February. It then traded between 2.8% and 2.9% until the end of the quarter when it dipped back under 2.8% after the recent turbulence in the equity markets.
The UK ten-year Gilt yield moved in the same way, starting the year at 1.2% and rising to over 1.6% by mid-February, before falling back again to finish the quarter at 1.4%. These end-of-quarter declines in yields suggests that bond investors are less worried about inflationary pressures feeding through than before.
After years of gorging on corporate debt almost indiscriminately, investors have become more disciplined when it comes to new issuance. According to Bloomberg, sales volume for new investment-grade corporate debt is at its lowest level so far this year since 2014. The market value of investment-grade debt has more than doubled over the last ten years as companies used the favourable conditions to issue cheap debt.
However, recent net outflows from bonds and a reduction in appetite has resulted in average yields at their highest in around six years. Despite a tough quarter for corporate bonds, there are no significant signs of stress in these markets at present.
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