An end to the crisis-era Quantitative Easing and gradual interest rate rises loom across the globe
US
The US Federal Reserve will throw its 2008 Financial Crisis stimulus programme into reverse from next month in starting the unwinding of its $4.5 trillion balance sheet. The ‘Fed’ accumulated this balance sheet from buying distressed debt from distressed US financial institutions during the financial crisis. At the moment, the US central bank reinvests the payments it receives on the portfolio of bonds and mortgage-backed securities it amassed during the crisis. When the balance sheet run-down starts, the Fed will phase out those reinvestments.
Similarly, US interest rates are also set to rise albeit slowly. The target range for the key ‘Fed Funds’ benchmark interest rate is currently 1 per cent to 1.25 %.Investors see a 50-50 chance of two quarter point rate increases by the end of next year. The market believes eventually the Fed Funds rate will end up at 3% representing the ‘normalisation’ of US interest rates, a goal of the US Federal Reserve.(Question: Why does the US Central Bank seek this ‘normalisation’. Answer: What if we had another financial crisis? If US interest rates were at rock-bottom the Fed could not lower them – they would be powerless. If rates are 3%, they have room to manoeuvre).
Consequences
- Higher interest rates should support the US Dollar but interest rate rises will only be gradual. The dollar is approximately 10% weaker since January because of this benign outlook.
- US Treasury bond yields should rise gradually with interest rates.
- US Equities are at record highs. If US rate rises are only gradual this is not a problem for the market.
Europe
Similarly the European Central Bank has indicated that it will wind down its asset purchase scheme as it responds to firmer growth in the Eurozone. An improving eurozone economy has already led the ECB to scale back its purchases by €20bn a month to €60bn in April, sharpening expectations that policymakers will set out a timeline for further tapering in the next couple of months.
Consequences
- The Euro currency has been the biggest beneficiary of a stronger economic outlook in Europe rising from broadly 1 EUR = $1.05 to 1 EUR = $1.20 over the past several months. A strong EUR is bad for European exports but overall European equity markets are well supported by the brighter economic outlook.
UK
Likewise UK interest rates now look to set to rise from rock-bottom levels. Markets see a 60% probability that the Bank of England will raise interest rates to 0.5% at its next meeting, as the need to tame inflation (circa 3%) becomes more pressing. In a year the rate is expected to be 0.75%.
Consequences
- Sterling is benefiting from the higher interest rate outlook and over the last few months has rallied from 1 GBP= $1.20 to 1 GBP = $1.35.
- The FTSE 100 equity index has fallen a couple of a per cent from its highs as a many FTSE 100 company constituent companies are global conglomerates and benefit when the pound is weak as they then translate their significant overseas profits back into Sterling.
Equities
S&P 500: 2500
Nasdaq: 6450
FTSE 100: 7275
Bonds – 10 Year Government Yields
US 2.24%
EU 0.45%
GB 1.38%
Foreign Exchange
EUR/USD 1.2000 (1 euro buys 1.2000 dollars)
GBP/USD 1.3500 (1 pound buys 1.3500 dollars)
Commodities
OIL: Brent: 55.00 (dollars per barrel)
GOLD: 1310 (dollars per ounce)
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