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US Interest Rates 

US Interest Rates dominated financial markets last week. Such rates are set by the FOMC (Federal Open Markets Committee) which meets approximately every 6 weeks. Federal Reserve Chair Janet Yellen sounds like she’s on a mission to raise interest rates this year – no matter what President Donald Trump does on tax cuts and spending.

The ‘Fed’ has an unwavering commitment to ‘normalising’ interest rates. The average key ‘Fed Funds’ rate (the rate at which banks lend to each other via deposits placed at the Federal Reserve) is 5.95% looking at the last forty years. The ‘Fed Funds’ rate before last week was 0.50-0.75% per cent which is still a financial crisis inspired accommodative or emergency rate and perhaps not appropriate for a US economy getting a growth infusion from Trump.

Last week the US Federal Reserve delivered a 25 basis point (0.25%) rate rise but in its meeting minutes stayed cautious regarding the pace of future tightening. The central bank stuck to its forecast of three (0.25%) rate increases this year and three in 2018, disappointing some in the markets who had anticipated a more aggressive path. (Market terminology – a softer policy stance is seen as “dovish” and good for stocks and bonds. If the central bank had indicated a quicker pace of interest rate increases this would have been “hawkish” and similarly bad for stocks/bonds).   

How did the markets respond to this more “dovish” stance?

US Dollar:  The US dollar continued to retreat. Currencies strengthen when interest rates rise and vice versa i.e. you can simply get a higher return on your money in a high interest rate currency. The dollar index, a measure of the US currency against a weighted basket of peers, was down to 100.38 leaving it 1.3% down on the previous couple of days and below the January 14-year high of 103.82. Overall the US Dollar was strong in 2016 but has failed to make further gains in 2017.

Equities: Many developed world stock markets remain at, or close to, record highs driven by the improved global economic outlook particularly in the US (Trump inspired) and Europe. The growing belief is that European economies are finally emerging from the economic malaise of the last several years.

Bonds: The bigger picture is that global bond yields have risen sharply since last summer, particularly in the US, as stronger economic growth, higher inflation and higher interest rate are bad for bonds. Indeed, many investors have rotated out of bonds into equities. A good benchmark to follow is the 10-year maturity US Treasury bond yield. The low yield was 1.32% yield-to-maturity last summer. The yield today is 2.53, just short of the last Tuesday’s two-and-a-half-year peak of 2.63%.

European bonds have also seen yield rises over the past few months but not to the same extent as the US. The 10 year German Government Bond (known in the market as “Bunds”) trades at 0.45% yield having traded at a negative yield-to-maturity in 2016 and short maturity 2-year German Bunds are in high demand yielding minus 0.81 YTM. Part of the demand for the latter comes from European safety concerns driven by political issues but there was relief in Europe last week at the poor performance of Geert Wilders’ Eurosceptic Freedom party in the Dutch election offering some support to the Euro currency also.

Gold: The ‘yellow metal’ extended its rally this year as fears that the Federal Reserve would signal a much faster pace of rate rise has failed to materialise. Gold does better in a low interest rate environment as it is a non-interest bearing asset.

UK: Despite another turbulent week in British politics, the pound ended the week on a firm note at $1.24 brushing aside the latest bout of Brexit nerves and fresh worries about a break-up of the UK.Indeed,Theresa May dismissed the Scottish call for an independence vote before Brexit

The Bank of England Monetary Policy Committee voted to keep interest rates at 0.25% but, for the first time, the decision was split, with one of the nine members seeking an increase.The market viewed this as “hawkish”.The FTSE 100 index nonetheless closed at a record high.

Oil: OPEC said it may extend oil-supply cuts if stockpiles stay above the five-year average.That was one factor that helped crude toward its first weekly advance this month.Generally, oil has been quite range-bound since November at close to $50 per barrel.

Interestingly, Shell CEO Ben van Beurden has warned global energy leaders to brace for the shock of falling oil use as soon as the 2020s, warning that those who trivialise the threat of climate change will exhaust public tolerance for fossil fuel companies if they are not careful.This has huge project investment implications for oil companies if oil stays close to $50 per barrel.The days of $100 oil may well and truly be over!

Equities

S&P 500: 2380

Nasdaq: 5890

FTSE 100: 7415

Bonds – 10 Year Government Yields

US 2.53%

EU 0.45%

GB 1.30%

Foreign Exchange 

EUR/USD  1.0700 (1 euro buys 1.0700 dollars)

GBP/USD  1.2400 (1 pound buys 1.2400 dollars)

Commodities

OIL: Brent: 51.00 (dollars per barrel)

GOLD: 1230 (dollars per ounce)

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