Tags: fed | ecb | boj | interest | rates | rate | bond

On Tap: A Foaming Flagon of Higher Interest Rates

Sunday, 03 Apr 2011 03:20 PM

The new quarter is bringing with it a new danger for investors — the withdrawal of the easy money that saw them through the financial crisis.

The European Central Bank is widely expected to raise interest rates on Thursday, fearful that above-target inflation will become embedded.

At the same time, members of the U.S. Federal Reserve have been making hawkish sounds about what will happen when its pump-priming quantitative easing programme closes in June. They meet later in the month.

The Bank of England, meanwhile, should keep rates on hold at its meeting on Thursday, but the panel's tightening advocates are getting noisier.

What is behind it all, of course, is the fact that the global economy, including its lagging western bits, is doing quite well and central banks want to make unusually accommodative policy just that — unusual.

"When things get better, ironically, this is the time to worry as authorities could withdraw support and subsequently impact on the corresponding risk markets," London & Capital told its clients.

There are already signs that the prospect of higher interest rates is weighing on the bond market, with the ECB's likely move particularly hard on the euro zone's embattled peripheral debt in Greece, Portugal and Ireland.

Overall, March was a month of extraordinary risks for investors — from Japan's triple disasters to civil war in oil-producer Libya — yet there was no flight to the supposed safety of bonds.

Reuters asset allocation polls for the month found that global investors actually cut overall bond allocations as well as generally walking away from government, investment grade and high-yield fixed income.

Investment bank Citi's government bond returns data, meanwhile, shows overall losses for March and the year as a whole. In local currency terms, its World Government Bond Index lost 0.14 percent in the month and 0.65 percent for the year-to-date.

It is not all because of interest rate expectations, but it is hard to imagine this pressure will dissipate in the weeks ahead as tightening approaches.

GOOD AND BAD

The story for equities — which are barrelling along again after cooling for much of March — is more complex.

Typically, the beginning of a tightening cycle is often good for stocks because, as Klaus Wiener, head of research at Generali Investments puts it, investors see the moves as a vote of confidence in the economy.

The first hikes are also generally meaningful only as a message rather than having a fundamental impact. The ECB, for example, may raise rates from 1 percent to just 1.25 percent — which would still be a negative real-term rate given inflation is running at 2.6 percent.

The big impact comes later, when the tightening cycle starts to bite on the economy and the yield curve flattens, essentially making short-term borrowing expensive.

Wiener reckons that is a long way off, but does add that there is a different wrinkle at the moment — easy monetary policy in a number of places has included quantitative easing, pumping money into markets by buying bonds.

Such a flood of money has been a major driver in the stock market rally that began in summer last year and has lifted the MSCI all-country world stock index by 30 percent or more.

"If they stopped adding liquidity, that would hurt a bit," he said.

Different rate expectations, meanwhile, have a profound effect on currencies. The euro and dollar have already strengthened while Japan's yen has weakened.

The Bank of Japan on Thursday is expected to say it has left rates on hold, but additional monetary easing cannot be ruled out given the economic damage from the earthquake, tsunami and nuclear breakdown.

What is allowing the other major central banks to start thinking about or actually withdrawing their hugely accommodative policies is the growing belief that the world economy is not only on the mend but growing sustainably.

The banks have to balance the danger of allowing growth to fire up inflation against tightening too soon and throwing the baby out with the bathwater.

This makes investors even more keen than usual to get evidence about how well various economies are faring.

March global services PMIs will take the temperature during the coming week.

And the Organisation for Economic Co-Operation and Development will put out its latest economic outlook on Tuesday, a taster ahead of the International Monetary Fund/World Bank reports that accompany their spring meeting the following week.

© 2017 Thomson/Reuters. All rights reserved.

   
1Like our page
2Share
Headline
The new quarter is bringing with it a new danger for investors the withdrawal of the easy money that saw them through the financial crisis. The European Central Bank is widely expected to raise interest rates on Thursday, fearful that above-target inflation will become...
fed,ecb,boj,interest,rates,rate,bond,stock,invest,england,bernanke,economy,inflation
728
2011-20-03
Sunday, 03 Apr 2011 03:20 PM
Newsmax Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved