Portfolio Manager
 Insurance Linked Funds
 Fund Tools
 Fund Selector
 Funds to Explore
 Category Quickrank
 Guaranteed Funds

International Fixed Interest and Equities Outlook – 2014 August

The move to higher interest rates would not be uniform across countries. A key question for investors is the outlook for the US economy and its implications for global financial markets.

International Fixed Interest – Outlook
Bond yields had been expected to rise from what have looked like unusually low and unsustainable levels but those expectations have been confounded as yields have stayed stubbornly low.

The move to higher interest rates would not be uniform across countries. While even as bond yields rise in some of the better performing economies, notably the US and the UK, some bond markets are unlikely to follow soon, with both the eurozone and Japan likely to persist with ultra-easy monetary policy for some time. In the eurozone, the European Central Bank (ECB) is struggling with both a weak economy and lower inflation than the ECB would like to see. The latest inflation estimate, at 0.5% for June, is well below the 2% that the ECB is meant to be targeting. Japan is also still midway through a large planned boost to its money supply to reverse its previous deflation (consumer prices fell each year from 2009 to 2012).

Nonetheless, interest rates must rise as central banks begin to reduce the degree of monetary policy support they have been giving to moribund economies. For the US, the latest economic data points to an economy beginning to use up its spare capacity faster than expected and that consequently rising inflation is closer than anticipated.

In a recent speech, one of the Fed governors came to much the same conclusion, noting that a year ago the Fed's view was that unemployment would be 7% now whereas it is actually 6.1% and he also noted that the Fed had expected to be finished with its bond purchasing program by now, though in fact it is still going, albeit at a reduced rate that will finally taper off to zero in October. Unemployment markedly lower than expected and more monetary stimulus than originally planned, add up to supporting an earlier move towards less supportive monetary policy.

Even on the current consensus view in the markets, interest rates are set to rise in 2015. Of the 15 participants surveyed in the Fed's latest policy meeting, 12 believe the first Fed funds rate increase will occur in 2015 (one picked this year, two picked 2016), while most economists surveyed by The Wall Street Journal also expect an increase next year (the June quarter is their most likely pick). The economists also expect bond yields to rise, with the 10 year US Treasury yield expected to be 3.2% at the end of this year and 3.75% by the end of 2015. In the UK, it is possible that bond yields are on the move already.

International Equities – Outlook
A key question for investors is the outlook for the US economy and its implications for global financial markets, with the recent focus on how strongly it may be growing and the consequences of strong American growth for Fed monetary policy and for knock-on effects on global interest rates and global equities.

June's payroll numbers were strong – 288,000 new jobs in the month, well above the forecasters' pre- release consensus of 211,000 and unemployment dropped to 6.1%, again lower than the consensus expectation of an unchanged 6.3% – giving rise to speculation about whether tighter Fed monetary policy is on its way sooner than previously thought. This gives rise to concern about whether international equities markets are prepared enough to absorb an unexpectedly early rise in interest rates. For one thing, investors seemed to be far too relaxed about potential issues. The VIX, which is an estimate of the volatility investors expect in the US share market, fell to a seven-year low in early July and similar measures in other markets are showing investors are unusually relaxed about events. While, good performance of the US economy may have a lot to do with it, it also possibly reflects complacency on the part of market participants about potential risks. 

About Author  Morningstar Analysts

Morningstar Analysts