The wobble in international stock markets may seem a bit odd, in the wake of recent upgrades to forecasts for world economic growth this year. Stronger growth pushes up company earnings. Right?
Of course this is true, but it is the other side of the growth equation that is worrying markets – the threat of higher interest rates spurred on by rising inflation. Since the crisis ended, markets have been supported by super-low interest rates. Even after successive hikes, the key Fed US short-term funds rate is still between 1.25 per cent and 1.5 per cent and ECB rates remain at zero.
So why the panic? Bond and equity markets always look ahead and the key change in recent months has been the increase in long-term interest rates, particularly in the US, which is well ahead of Europe in the economic cycle.
US 10-year interest rates are now more than 2.8 per cent, having risen significantly in recent weeks.
The immediate cause of the latest jitters were figures on Friday showing US wage growth was 2.9 per cent, its highest level in a decade. This has not fundamentally changed the outlook for US interest rates – the Fed, now under new chair Jerome Powell, has guided that there will be three more rises this year, and the most there will be is four.
But, as sometimes happens, the data seems to have focused minds in the markets on the risks ahead.
The price of money matters. For investors, rising government bond rates, offering a safe return, set the bar higher when they are looking for returns elsewhere from riskier assets – equities, for example.
Bond rates are are also used to price long-term finance for companies and thus may put more highly leveraged corporations under pressure. They also feed into longer-term fixed mortgage rates for customers and are used to assess the return on all kinds of investment plans.
While everyone expected interest rates to start returning to more “normal” levels after the crisis, signs that this is now happening are still causing some jitters.
Were the markets – where company valuations are high – lulled into a false sense of security?
The betting must be that there is more of this to come, particularly if US 10-year rates head over 3 per cent.Tags: Business, Cantillon, Ecb, Europe, Jay Powell, Markets, United States