17 October 2016

Over the past week Australian shares were 0.6% lower. Shares in developed countries lost 1.1% with the US market down 1%. Shares in emerging markets lost 1.9%. The Australian dollar was 0.5% higher at 76.18 US cents. The 10 year bond yield in Australia was 0.09% higher at 2.26% while in the US, the 10 year bond yield closed the week 0.08% higher at 1.80%. The oil price gained 1.1% to 50.35 US dollars per barrel.

We see much mention in mainstream media about the potential for higher interest rates. In its usual way the media suggest that this could be disastrous for financial markets.

What could a rising interest rate environment actually look like? First, it could be quite different across countries and regions. For instance we see little likelihood of interest rate increases in Europe and Japan over the short to medium term. They are economies facing major structural challenges.

The US and Australia have a greater likelihood of higher interest rates over the medium term. Indeed the US Federal Reserve, the US’s central bank, has indicated that it’s looking to raise rates from abnormally low levels once they have confidence that there’s a sustainably healthy economy.

At the US Federal Reserve each member makes their own personal forecast of how the economy will perform and where interest rates will be set. The central range in forecasts, which captures the consensus view of projections, for year end official interest rates is set out in the table below.

 

2016 2017 2018 Long term
Central range of forecasts for year end interest rates 0.6% - 0.9% 1.1% - 1.8% 1.9% - 2.8% 2.4% - 3.0%

 

We can make some interesting observations from this table. Firstly, the pace of interest rate increases is expected to be gradual rather than fast. Secondly, the forecast is for low interest rates over the long term.

While interest rates are likely to rise over the medium term in some countries, like the US and Australia, increases will be moderate. We’re likely to remain in a low interest rate world for many years to come.

Signing off
David Bell

Past performance isn't necessarily an indicator of future performance. All data sourced from Bloomberg and the US Federal Reserve.