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Interest Rate Relief Valve
Global growth obstacles are rising as trade tensions build, but we expect lower U.S. interest rates to help soften the blow. Chief Investment Strategist Jim McDonald explains.
- Global Growth Slowing
- Well Ahead of the Fed
- Right Conditions for Risk
Global growth obstacles are rising as trade tensions build, but we expect lower US interest rates to help soften the blow. Leading economic indicators have weakened as the US has started aggressively using tariffs as an economic and political tool. We have seen a marked deterioration over the last month in the negotiations between the US and China, further increasing the headwinds to growth.
At the beginning of the year, we felt investors had become too pessimistic about growth and markets were positioned to surprise to the upside. The recent increase in trade tensions along with the rally in markets has shifted the outlook to a more balanced one. We think the weaker growth outlook over the next year will be cushioned by three cuts in the fed fund rate by year end.
The bond market has been well ahead of the Fed in anticipating the need for lower interest rates. Interest-ratesensitive sectors were hurt by rising rates in 2018 and have rallied in 2019 as a result of lower rates. In the housing sector this year, mortgage applications and refinancings have recently spiked, and home-building stocks have rallied more than 25%.
Lower inflation is also supporting the case for lower interest rates as core inflation in the major economies is barely above 1 and 1/2% and is trending lower. Financial markets, meanwhile, have lowered their expectations for inflation over the next 10 years from nearly 2.2% last year to 1.7% today. We think this softening inflation outlook will provide the necessary cover for the Fed to reverse course and cut rates meaningfully this year.
We expect lower interest rates to offset the softer growth environment, allowing risk assets to remain attractive. In our global tactical asset allocation model this month, we reduced our recommended exposure to high-yield bonds and emerging-market equities, reinvesting the proceeds into global-listed infrastructure and investment-grade bonds. These changes should better position the portfolio for the low-interest-rate environment and also somewhat reduce our exposure to trade risks.
Our risk cases continue to highlight the disruptive potential of a return of inflation along with the upside risk case of a trade armistice being reached between the US and China. This upside risk case could actually improve the outlook for global growth and investor risk appetite.
Read more about our current investment strategy in our perspective newsletter later this week.
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Chief Investment Strategist
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November 4, 2019
The Federal Reserve last week lowered rates for the third time over the past year. Interestingly, Chairman Jerome Powell said the Fed thinks interest rates are in a good place at the moment, telling investors that it may be time for a pause. We think this is a mistake by the Fed. Head of Fixed Income Colin Robertson explains.
July 29, 2019
All eyes are on the U.S. Federal Reserve this week. While most investors expect an interest rate cut, recent Fed communication has reflected some lack of consensus on the magnitude. Katie Nixon takes a closer look.