More rate hikes to come in the US as tax reform looks set to go ahead.
The European Central Bank (ECB) will reduce asset purchases further in 2018 but muted inflation should keep rates unchanged.
With slower growth and lower inflation, the Bank of England (BoE) is likely to stay put in 2018.
Favour short maturities and inflation-linked bonds.
Fed to hike rates again
"The US tax boost could strengthen rate hike expectations."
While the economic recovery could have been expected to drive prices higher, globalisation, digitalization and robotization are likely to keep inflation muted worldwide. This means we should not expect much from central banks, especially given high debt levels in the private and public sectors.
US Federal Reserve to hike rates again. Stronger growth and higher inflation could lead to further rate hikes. The monetary policy committee projects three moves next year while market expectations are for only one. Much will depend on data – any inflation surprise could cause turbulence as investors prepare for higher rates. The tax boost and cuts in asset holdings could add to upward pressure on long-term rates.
Prefer short maturities. In the US, higher inflation and rate hikes could drive long-term bond yields up in 2018. With long-term yields still low, even a slight rise in interest rates could translate into negative returns. The upward pressure could spread to other fixed-income markets despite divergences in monetary policy. After ECB purchases kept core yields artificially low this year, we expect them to rise in 2018, narrowing the gap with US Treasuries. Non-core bonds are attractive for their carry and spreads could tighten further, although much depends on macro and politics. In the UK, where weaker growth and high inflation are pulling in opposite directions, bond yields are likely to move higher in sympathy with the US and eurozone. Overall, we still prefer short maturities and inflation-linked bonds.
The ECB and BoE won’t walk the talk
"We expect no rate hike before 2019 – at earliest."
ECB in slow motion. Despite stronger growth, the European Central Bank (ECB) expects inflation to stay below target until 2019. The central bank has decided to shrink its monthly asset purchases next year but will continue buying through to September. Given strong growth and the revival in bank lending, the ECB will come under pressure to wind down the programme earlier, but no debate is likely before mid-2018. Nonetheless, any tweaks to current monetary policy should be considered as a step towards normalization. However, there is little hope of rate hikes next year with inflation kept persistently low by the slow improvement in job data and the stronger euro. Moreover, any moves to take the deposit rate back into positive territory could prove counterproductive as they could push the currency even higher. We expect no rate hikes before 2019 – at the earliest.
Bank of England – staying put. In late November, the BoE raised its key rate by 25 basis points. However, this move had more to do with excess credit than any economic improvement. In 2018, softer growth and weaker inflation should encourage the central bank to stay put, especially as current low Gilt yields reduce its room for manoeuvre. Brexit talks will also remain of great consequence for the country’s economic outlook and monetary policy.
Sources: SGPB, Bloomberg, 30/11/2017. Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.