Fixed-Income Outlook: Higher Rates Still Challenged by Politics

Thierry Million | 15/05/2017
Fixed Income Newsletter May 2017


While economic signals point to an improved environment for global growth – laying the groundwork for an increase in interest rates in some regions – political uncertainties still weigh heavy across many fronts.

Macroeconomic indicators globally continue to beat expectations, foreshadowing a stronger global cyclical recovery, despite the increase in political and geopolitical incertitude on many fronts.

Encouragingly, the general recovery appears to be more broader-based than last year, amid signs of an economic improvement among emerging economies including Brazil and Russia. The US and China remain the main drivers underlying global growth, followed by the euro zone.

Rates are set to rise in the US

US business and consumer confidence remain strong, even before the implementation of the so-called reflationary reforms promised by President Donald Trump. The prospect of a more expansionary budgetary policy over the next few quarters should be taken into consideration. However, the composition and timing of potential tax reform remain uncertain as President Trump’s administration is not entirely free of constraints – as demonstrated by the difficulties encountered repealing the Affordable Care Act. In any case, the effects of further stimulus measures will not kick in until 2018.

Against this more buoyant backdrop, headline inflation in the US – as gauged by the household expenditure deflator – is already at 2.1 per cent, with core inflation reaching 1.8 per cent. The US Federal Reserve can pursue its monetary-policy normalization strategy through two further rate hikes by the end of the year, and even begin to reduce the size of its balance sheet by halting reinvestments. Technically, this move should drive yields higher by increasing the supply of available securities for investors. However, long-term Treasury yields are easing as the markets believe that a reduction in the Fed’s balance sheet may slow the pace of base rate hikes. The US yield curve term premium is contracting, amid increasing geopolitical tensions involving the US.


Positive EU outlook challenged by political uncertainty

In the euro zone, the economic outlook remains promising despite political uncertainty stemming from Brexit and forthcoming elections around the region. The euro zone is facing the challenge of maintaining its current growth rate over the next few quarters. Given the absence of core inflationary pressures, the European Central Bank should contribute to the growth outlook, as it is unlikely to taper its securities purchase programme until early 2018. The ECB could adjust its forward guidance in September of this year. In anticipation, interest rates, which are currently exceptionally low across the entire German yield curve, would trend toward a higher equilibrium level. This scenario could nonetheless be jeopardized by significant downside risks due to the political uncertainty that is threatening to destabilize the euro zone.

The rise of anti-European sentiment in France made the markets wary of French government bonds, with the spread over Germany widening. Heightened nervousness has also spilled over to Italy and Spain. And although the winning candidate in France’s recent presidential elections, Emmanuel Macron, is pro-Europe, risk premiums will not ease significantly. The forthcoming elections in the UK and Germany will provide further sources of volatility.

How long will politics undermine rate hikes?

Higher interest rates, which usually accompany an improvement in the economic situation, are therefore temporarily undermined by mounting political issues. If these issues prove to be only temporary, fundamental factors will remain firm and take centre stage once again, reconstituting the term premium through higher interest rates.

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Thierry Million

Head of Institutional Fixed Income, France

How Innovation Creates Opportunities Late in the Cycle

Karen Hiatt | 16/05/2017
How Innovation Creates Opportunities Late in the Cycle


In high-priced markets, there are good reasons to look for innovative companies that thrive off disruption. Many are highly valued with good cash flows precisely because they have products and services that consumers consider essential, which could bode well in a downturn.

Key takeaways

  • Some of the largest gains in an investment cycle are left to the end; exiting too early can mean a sizable loss of opportunity
  • Today’s most innovative companies have good cash flows and can drive their own profitability expansion
  • Big cloud computing firms help clients cut costs and boost productivity without massive investment – just what clients need as economic tailwinds subside
  • Investing in companies with differentiated services and measurable returns could add valuable diversification
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