2018 commenced with expectations for tighter global monetary policy, essentially higher interest rates, as central banks reduce emergency settings post the Global Financial Crisis. We commence 2019 with lower expectations for policy tightening but less clarity as to the direction of interest rates.
At its December meeting the US Federal Reserve (“Fed”) increased its cash rate a quarter of a percent, bringing the rate closer to their estimate of the neutral rate. The neutral rate, is the cash rate that neither stimulates (speeds up) nor restrains (slows down) economic growth. Concurrently with increasing its cash rate the Fed continues to reduce the size of its balance sheet (the size of its quantitative easing), essentially reducing the amount of bonds it buys and holds from the market.
Prior to December’s meeting indications of Federal Market Open Committee (the group within the Fed that decides on interest rates) members’ expectations had pointed to three increases in the cash rate for this year but this has been reduced to two. Notably post December’s market volatility and evidence of slower growth, the Fed provided assurances that they will be flexible, patient and attentive to market signals in how it deals with monetary policy going forward.
This contrasts with the European Central Bank (ECB) which stopped expanding its asset purchase program (“Quantitative Easing”) in December. However, unlike the Fed, the ECB remains a long way off reducing the size of its balance sheet. Simultaneously the cash rate in Europe has remained negative. Despite ECB guidance for rate hikes to commence post the northern hemisphere summer this year, there is a lack of confidence in the market that the ECB will do so. This is a similar scenario to the Bank of Japan which is keeping negative cash rates and has an ongoing commitment to quantitative easing.
Closer to home, cash rates in New Zealand and Australia have been on hold for over 2 years at record low levels. It looks like they won’t be increasing any time soon. Irrespective of high levels of employment, wage inflation remains muted and Consumer Price Inflation is below central bank targets. Furthermore, both economies face the threat of a Chinese slowdown and slowing housing markets, impacted by reduced availability of bank lending. This has led to the market pricing possibilities of cash rate cuts in both countries this year.
Interest rates remain at historically low levels globally. Central banks still appear to have a preference to increase cash rates to exit emergency monetary policy settings. Thus far, excluding the Fed, muted inflation and an increased threat to global growth have prevented them from doing so. The risk is if growth slows, some central banks may have missed an opportunity to increase their cash rates, leaving less room to stimulate economies in the next economic downturn.
All in all, this makes for a more uncertain environment for interest rates, albeit one which is moderately supportive for fixed income given the lower chance of a spike in interest rates.