Global interest rates have moved higher in recent months.
This move began with tentative signs of higher wage growth and inflation in the US as the world’s largest economy continues to recover from the GFC. It has accelerated since the election of Donald Trump.
Several of the economic policies that Trump campaigned on, including low taxes, higher fiscal spending on infrastructure, tighter immigration and reviews of existing free trade deals, are likely to lead to higher inflation in the US.
This partly reflects the lack of spare capacity in the US economy, as demonstrated by an unemployment rate of just 4.9%.
These inflationary concerns have been the key driver of the recent increase in US interest rates.
Positively, we think some of these policies will also lead to higher US growth, especially the tax cuts and infrastructure spend.
Much will depend, of course, on the extent to which Trump’s pre-election rhetoric is translated into actual policy.
While this ‘policy bite’ remains uncertain, Milford’s conclusion is that US growth, and especially inflation, are likely to move higher. We have positioned for this in the past month across our funds, particularly those with fixed interest exposure (that is, we have reduced these Funds’ exposure to higher interest rates).
Where do US interest rates go from here?
In our view, pressure over the next several quarters is likely to remain for a further move higher.
However, there are several important factors that we believe will keep that to a moderate increase, rather than a move back, for example, to the 4-6%-plus interest rates of years gone by. These include;
- Continued bond-buying (quantitative easing) by central banks in Europe and Japan
- High level of debt in the US and global economy
- Higher US interest rates are likely to drive a stronger US dollar, which will keep a lid on US growth and inflation
- A stronger US dollar creates economic headwinds for China, given the managed exchange rate between the world’s two largest economies. Restrictive trade policies could also impact negatively on China.
- The extent of the expected move higher in US inflation is small. Traded inflation markets currently indicate expected ten-year average US inflation of 1.9%, up from 1.5% in June[1].
What do higher US interest rates mean for NZ?
In short, we don’t expect to see the same inflation and growth impact from Trump in NZ as in the US. NZ would get some benefit from stronger US growth, as it accounts for 12% of our exports[2]. However, as a small open trading economy, the potential for more protectionist global trade policies is negative for NZ.
With a mix of costs and benefits for NZ, we see little change to the outlook for the Reserve Bank of New Zealand – the official cash rate is likely to be on hold for some time.
The increase in longer-term interest rates, both in NZ and overseas, does provide a headwind to our share market. The relative safety and high dividend yields in our market have been a key driver for high levels of foreign buying of NZ shares in recent years. With higher yields available from international bonds, we expect to see this demand for NZ yield-oriented shares ease.
Despite this, we still think the NZ share market has good foundations to perform well, particularly our more growth-oriented companies. Our economy is growing very strongly, profit growth is robust, corporate balance sheets are in good shape and interest rates here are still low, particularly in historic terms.
David Lewis
Portfolio Manager
Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.
[1] Bloomberg
[2] Statistics NZ