By Roger J Kerr
The interest rate environment at the start of 2018 is certainly different to how it has been over recent years.
The global financial and investment markets have already voted with their feet in anticipating that inflation will increase in most western economies this year and that money printing in Europe is finally ending.
The result is material increases in US long-term interest rates over recent weeks from 2.30% to 2.66% as the super low yields in Europe no longer holds US yields down.
Outside of global geo-political shocks or risk events (resulting in safe haven buying of bonds), it is difficult to see who the big buyers of US Treasury bonds will be to return the yields to lower levels.
As US inflation and short-term interest rates increase through this year expect to see US long-term yields pushing even higher to 3.00%.
The implications for our medium and longer-term swap interest rates are obvious.
The rise in the oil price over recent months has also been a contributing factors to the higher US interest rate yields.
Shale oil production in the US provides a natural cap to continuing oil price increases and it appears that the oil market has sold prices too high, too quick.
I would not expect to see oil prices any higher – and a pull back to below US$60/b in Brent may be one variable that slows down the increase in long-term interest rates.
The chart below plots the US Treasury Bond “bull market” (yields lower, bond prices higher) that has run since the yields were above 9.00% in 1988.
The Fed Chairman in the mid 1980’s, Paul Volcker (those with grey hair such as myself will be old enough to remember him!) was very successful in taming the inflation beast that started the decline in interest rates.
The bond market threatened to move yields above the downtrend line in 2008, only to be gazumped by the GFC.
Today the downtrend line is again under threat as the world economy finally moves on from the super loose monetary conditions that were required after the GFC.
Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com