Interest-rate outlook as global growth improves

The 10-year Canadian government bond yield has retreated from its 2017 peak yield of 1.87% and currently sits in the middle of this year’s range of 1.61% – 1.87%.¹ Economic data has generally been picking up this year with employment growth showing particular strength. The Bank of Canada has kept policy on hold recently, but remains wary of persistent economic slack. We believe the current trading range is likely to persist unless global economic growth picks up further.

Below is an overview of the Invesco Fixed Income team’s outlook for interest rates in key world economies:

United States

Strong global growth should ultimately pressure U.S. yields upward as global monetary policy tightens. In the short term, however, the Fed has indicated that it does not intend to tighten interest rates quickly. Moves from other central banks, such as the ECB, will likely drive price action in longer-dated U.S. interest rates. As global growth continues to improve, other global central bank actions may catalyze a move higher in U.S. Treasury yields.

Europe

We expect the ECB to move away from its ultra-dovish stance in Q2, clearing the way for a higher yield environment. Growth and inflation data continue to improve in the euro area, with headline inflation back to the ECB’s 2% target.² Nevertheless, ECB President Draghi has maintained his dovish rhetoric, although it may become more difficult after the April 23rd French election. To placate the northern European countries already experiencing inflation, the ECB might raise short-term rates while maintaining QE through year end.

China

The onshore Chinese government bond (CGB) yield curve flattened sharply in March. Short-term yields rose as liquidity tightened due to the quarter-end effect and more stringent macro-prudential assessment (MPA) measures implemented by the central bank (PBoC). Long-term yields, on the other hand, were dragged down by market expectations of slowing growth later this year and the PBoC’s longer-tenor liquidity injection. A short relief rally in the onshore bond market is expected in April after the recent funding tightness and volatility. However, we think short-term rates will remain sticky, as the PBoC’s efforts to reduce financial leverage are expected to continue.

Japan

10-year Japanese government bond yields continue to trade “around zero.” Inflation is on the rise, but still well short of the BoJ’s 2% inflation target. As a result, we do not expect tapering in bond purchases (or any other adjustments to policy) anytime soon. The near-term focus will likely be on the spring wage negotiations, which have the potential to boost inflation, but tend to underwhelm. We see no reason for this year to be any different. It is, therefore, difficult to see how Japan will reach its inflation target on a sustainable basis.

U.K.

The U.K. government triggered Article 50 on March 29th, setting off a two-year timetable to agree the terms of its departure from the European Union and to negotiate a new trading arrangement with the bloc. The European approach to these talks should become clearer after an April 29th summit, organized to discuss negotiation tactics. We would expect the opening stance of the Europeans to be one that suggests a difficult period of negotiation ahead, with the “divorce” settlement being the most contentious issue in the early stages. The Europeans are believed to want to agree to a financial settlement before turning their attention to future trading arrangements. The U.K. government, meanwhile, is believed to prefer discussing the settlement and future trading arrangements, hand in hand. It is difficult to see how everything will be resolved within the two-year time frame. We do not expect the Brexit negotiations to cause interest rates to break out of their recent trading range in the near term.

Australia

The Reserve Bank of Australia (RBA) held rates steady in March at 1.50%, as expected.³ The statement was a near repeat of February’s, with the RBA conveying continued positive expectations for the economy. With the RBA constructive and signs of economic strength in the data, it is highly unlikely that the RBA will need to lower the cash rate further. In fact, the market is now expecting the next move to be a rise in rates. However, the lack of inflation, especially in wages, despite a pick-up in growth, should keep the RBA on hold. Therefore, we expect Australian rates to be range bound in the near future and maintain a neutral stance versus U.S. rates.

With contributions from Rob Waldner, Chief Strategist, James Ong, Senior Macro Strategist, Sean Connery, Portfolio Manager, Scott Case, Portfolio Manager, Josef Portelli, Portfolio Manager, Ken Hu, CIO Asia Pacific and Alex Schwiersch, Portfolio Manager.