E Interest Rate Expectations Are Downgraded Worldwide

Worldwide the outlook for future interest rates has taken a major tumble as investors re-calibrate their expectations for rate changes in the future. Almost without exception, the yield curves in the major industrialized world are signaling that not only is economic growth slowly but that inflationary expectations are way down from those displayed six months ago and even from those of just over the past month.

Starting with the United States, the Fed rather abruptly announced a pause in its rate hike cycle in January. In addition, the Fed’s “quantitative tightening” program, designed to incrementally shrink its balance sheet will likely stop as early as September. Six months ago, the yield on the US 10-yr bond was 3.2% only to fall steadily to 2.63 % today (Figure 1). More significantly, the curve actually inverted in the mid-range between 2y and 5yr yields, suggesting that the majority of bond market participants do not anticipate any rate hikes in 2019. This perspective has been echoed by selective Fed speakers who cite the absence of inflationary pressures.

(Click on image to enlarge)

Figure 1 

Just a half a year go the Governor of the Bank of Canada told Canadians to be prepared for a “neutral” bank rate somewhere range of 2.5% to 3.5% (compared to the current rate of 1.75%). This statement initiated a sharp increase in the front end of the curve, although the long end remained relatively flat. As the results of the fourth quarter 2018 rolled in, it became very apparent that the Canadian economy was deteriorating. It did not take long for Governor Poloz to alert Canadians that the path towards higher interest rates is “highly uncertain”.[1]  Disappointing exports, especially in the energy sector, and the softness in business investment turned the markets’ attention to a faltering economy. The reaction in the Canadian bond market was swift as yields across the board fell and continue to fall this month (Figure 2).

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