2015 Third Quarter Outlook: The Road Ahead
Steve Locke, Lead of the Mackenzie Fixed Income Team, explains what may happen if the U.S. Federal Reserve raises interest rates in the third quarter.
Inflation and Interest Rates: Steve Locke on Fixed Income
Steve Locke discusses the interest rate backdrop and where U.S. and Canadian interest rates may be headed.
In our view, monetary policy divergences and global event risks will continue to be dominant themes in bond markets this year. In fact, the recent increase in volatility in U.S. bond yields reflects significant shifts in the markets' recent assessment for a potential increase in the U.S. Federal Reserve's key lending rate in 2015.
We believe the Fed will start with a 25 basis point increase this September, as long as the risks surrounding Greece and the Eurozone are contained. The bond market is somewhat priced for this by year-end, and for the policy rate to climb by approximately 75-100 basis points over the next 18 months.
We expect the pace of increases will likely be measured and slow, simply because the growth we have seen is not sustainable if rates rise sharply.
Even though near-term reported inflation rates could increase, as the impact of last year's falling energy prices recedes from the calculation, low rates of inflation are still the prevailing undercurrent in the global economy.
In part, this is the result of excess industrial capacity worldwide. High household and government debt levels in many countries will also require low interest rates to support that debt.
There are global risks if yields rise too much too soon. For one, without a broad-based improvement in economic growth, rising rates could hurt emerging market countries that have a lot of US dollar debt.
As for Canada, if energy prices stay low, there could be further damage to the Canadian economy, forcing the Bank of Canada to cut the overnight rate again in 2015.
So in summary, we expect a low range of bond yields to continue, even as the Fed begins a slow rise in their policy rate later this year. But don't expect the Bank of Canada to follow the Fed this time.
- As the Fed increases rates, there could be more volatility; however, it is likely that increases will be measured and slow.
- Low inflation and interest rates are still the prevailing undercurrent in the global economy.
- If the market perceives that rates are rising too quickly, it could hurt countries that have a lot of debt in U.S. dollars.
- The Bank of Canada may once again be forced to cut rates if oil stays in the $60 dollars a barrel range.