Watch Like a Hawk

Central banks such as the U.S. Federal Reserve Bank (Fed) use monetary policy tactics, including interest rate moves and increasing or decreasing the monetary supply, to try and influence the level of inflation, stimulate the economy and spur employment. A central bank’s focus can vary in different time periods depending what appears to be the most significant concern. For example, with economic growth and employment levels stable, the Fed has been tracking inflation closely, targeting a 2% inflation rate in the U.S. for 2017. At this time, inflation is running lower than the target rate. If it were running higher, however, and the Fed took a hawkish stance, it might raise rates sooner to try to bring inflation under control. A central bank that is less hawkish would be more concerned with stimulating economic growth and may keep rates low to encourage spending.

Fed leaning toward hawkish policies

With the U.S. leading the way in the post-recession recovery, the Fed has been one of the first central banks to turn more hawkish, increasing interest rates three times between December 2016 and the second half of 2017. While it has not given details on timing, in the last couple of Fed Open Market Committee (FOMC) meetings, the Fed has indicated its intent to slow down new purchases of Treasuries and agency securities as current holdings mature.

China follows the U.S.

China, the second largest economy in the world, has been aggressive in raising its rates. The People’s Bank of China has somewhat matched the U.S. in interest rate moves, for example raising rates in March shortly after the Fed raised its rates. It did not, however, raise rates in June when the Fed implemented another 0.25% increase in short-term rates. This could be in order to maintain a level of liquidity and/or to try and maintain a consistent economic growth rate.

Other central banks have been more dovish

Globally, economic recovery has not been as steady and stable as in the U.S. Consequently, other central banks have been more focused on economic stimulus versus inflation control. Japan, especially, has struggled for an extended period and also has a lower than expected inflation rate. PNC believes it is unlikely, therefore, that the Bank of Japan will move toward a more hawkish stance in the near term.

The tide may be shifting

Just one year ago, rates globally were dropping and even lower rates seemed likely. In August 2016, the Bank of England had lowered its interest rates to a historic low of 0.25%, and the potential existed for it to go even lower to be at parity with other countries that had lowered rates to 0% or even less. In recent months, signs are emerging that some central banks may be entertaining more hawkish sentiment. This has been reflected in market activity and currency movements, with growth globally picking up steam. Non-U.S. currencies too have benefited, with comments by European Central Bank (ECB) leaders including Mario Draghi driving up the Euro, which is now trading at its 2015 level. Market expectations point to a potential reduction in quantitative easing by the ECB sometime in 2018, as well as a possible increase in interest rates later in the year. While there have been fewer indications to date of a sea change among other central banks, sentiments appear to be on the rise that hawkish actions lie ahead. For example, the money markets in Canada and England have factored in the probability of an interest rate hike in late 2017.

Mixed signals for the U.S. may affect timing of rate hikes

In our view, what lies ahead for future rate movements in the U.S. is highly dependent on what happens with inflation in the next few months. Our current forecast is for another 25 basis point rate increase late this year or early next year. This is likely to be followed by the aforementioned reduction in reinvestment in Treasury and agency securities as they mature, assuming the economy maintains its strength. If inflation continues to run below the target 2.0%, we feel this could push the timing of the next interest rate hike out. This possibility was reinforced by the comments made after the September FOMC meeting, where the Fed maintained the current 1% to 1-1/4 % target rate “in view of realized and expected labor market conditions and inflation…”

Benefits of rate increases to individual

While a jump in interest rates does mean a tighter credit market, there are those who have the potential to benefit from higher rates. Higher U.S. rates should help strengthen the U.S. dollar versus other currencies, which would mean lower prices on imports. This could boost purchases of bigger ticket imports, such as cars. For those investors who are moving funds into fixed income investments, they have the potential to benefit from lower prices and higher yields. For older individuals and households that rely on income generation, higher rates can also be a significant boon.

Potential volatility ahead

To date, the markets have maintained their upward momentum and do not appear to anticipate the quantity of rate increases upcoming in the near to medium term as the Fed has indicated might occur. If this changes, there could be short-term market volatility. Overall, we are seeing a pickup in yields globally, resulting in narrower yield differentials between U.S. Treasuries and other sovereign bonds.

This in turn is facilitating stronger currencies versus the dollar. PNC continues to keep a close eye on developments globally, particularly in terms of how they may affect international investments. We maintain our focus on high-quality equity, fixed income securities and a diversified portfolio designed to achieve solid risk-adjusted returns.

 

Important Legal Disclosures and Information

The material presented in this article is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions expressed herein are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. You should seek the advice of an investment professional to tailor a financial plan to your particular needs. For more information, please contact PNC at 1-888-762-6226.


The material presented in this article is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions expressed herein are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. You should seek the advice of an investment professional to tailor a financial plan to your particular needs. For more information, please contact PNC at 1-888-762-6226.

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