Monthly update: Have interest rates finally plateaued?

Whisper it – after 18 months of fast increases, western central banks may finally be done hiking interest rates. The US Federal Reserve (Fed), Bank of England (BoE) and Swiss National Bank all decided against a further rate increase in October. We may not be out of the woods yet though. It’s worth noting that both the Fed and BoE have warned the door to further hikes remains open.

The Fed message that caught the most attention last month was that, while interest rates may not have to rise further, they could stay at current levels for longer. Markets now believe we won’t see a rate cut in the US until the latter half of next year. Sven Balzer, Head of Investment Strategy at Coutts, says, “Basically, central banks are continuing with their ‘data dependent’ approach, waiting for new inflation and labour information before their next meetings.

“Markets are monitoring this situation very closely – investors are increasingly hoping for an end to rate hikes. But there are other potential risks along the way.”

Those potential risks include what’s happening in China. The world’s second largest economy is still suffering from sluggish domestic demand and a property crisis. This could change if the Chinese government successfully puts a firm foundation under growth expectations through spending and tax policies. But efforts so far haven’t done enough to reassure investors.

Meanwhile, oil prices have been rising continuously in recent months amid supply concerns, edging ever closer to $100 a barrel at the time of writing. Some fear this could hamper central banks’ battle against inflation (although we feel we’re not there yet – see spotlight below).

Finally, although a US government shutdown was averted literally in the last minutes of September, the solution only funds the government until 17 November. Considering the limited time and large gulf between both houses of Congress, another looming shutdown is likely in November. Such shutdowns have in the past had limited economic impact, but they can reduce the amount of economic data available and cause uncertainty.

Despite these challenges, Sven stresses that there are reasons for investors to feel a little more positive.

“The robust US consumer and continued slowing inflation trends continue to support the macroeconomic outlook for now, which is supportive of risk assets,” he says. “Considering last month’s small correction in equity markets, our risk appetite has marginally increased.”

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs.

Reflecting the slightly more positive outlook, we’ve been positioning our investments for potential opportunities. We recently reduced our exposure to US government bonds and increased our allocation to UK corporate debt and global investment grade debt – which currently offer better yields.

On the equity side, our expectations for Japanese ‘value’ stocks (stocks that are more attractive than their earnings would suggest) have improved. Japan is currently leading global economic growth, posting better-than-expected annualised GDP growth of 6% at the end of the second quarter of the year. As a result, we’ve increased exposure, while reducing our investment in European value stocks which are more challenged.

Despite China suffering from a real estate crisis and Europe bordering on recession, both of which you’d think would lower the cost of oil, the price of black gold has been rising. Brent crude rose from $75 a barrel in June to over $97 at the end of September.

Production cuts are largely to blame, with both Saudi Arabia and Russia announcing reduced supply earlier this year.

Sven says, “While the rising oil price isn’t helping central banks’ fight against inflation, we don’t see it as a huge problem at the moment. It would have to stay over $100 a barrel for some time to become a serious issue for the economy. It does, however, reinforce the ‘higher for longer’ messaging on interest rates that we’re hearing from central banks.”

He adds, “Another potential impact is a political one. The average US retail gas price is already up almost 25% since the start of the year, according to the US Department of Energy. And with the US election set for November next year, this is increasingly becoming an issue because voters feel it directly in their wallets.”

Coutts’ clients can find out more about what’s happening in the investment markets and how it impacts their investments by speaking to their private banker.