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The prospect of higher rates forever

Picture of François Christen

François Christen

Chief Economist

Government bond yields stabilise, but a major monetary policy reversal remains unlikely.

Original article published in French on agefi.com

With just a few hours to go before an FOMC meeting of little relevance, dollar-denominated bonds are showing steady yields after several weeks marked by tensions. Despite a few minor surprises, the indicators published last week do not change the problem being tackled by the Federal Reserve and investors.

The preliminary estimate of US GDP growth turned out to be slightly weaker than expected. Forecast at around 2.5%, annualised GDP growth came in at just 1.6% in the first quarter. However, this gap needs to be put into context. Growth is difficult to measure, and is subject to major revisions, with annualised figures amplifying the divergence. In this case, the slowdown is essentially the result of a sharp rise in imports and a fall in changes in inventories. Domestic demand (or final sales) expanded by close to 3% in real terms (adjusted for inflation) and 6% in nominal terms (unadjusted for inflation).

With an annualised rise of 3.1%, the price index tied to GDP accelerated sharply from the 1.6% rate seen in the previous quarter. But this only confirms what we already knew: inflationary pressures intensified in January and persisted over the following two months. Excluding energy and food, the consumer spending index rose by 0.3% month-on-month in March, and by 2.8% year-on-year – the same rate as in February, and only slightly less than the 2.9% change seen in December. Inflation is thus too “sticky” to allow any easing in monetary policy.

Against this background, the FOMC meeting looks like a formality. There is no doubt that the status quo will be maintained, and we should not expect the slightest hint as to the path of interest rates. The statement should emphasise the importance of the incoming data, and we will have to wait until 12 June to find out what the central bank plans to do next. Without waiting for the FOMC’s deliberations, the market has taken on board the prospect of persistently high interest rates, even if the CME’s futures forecast a first cut in the policy rate on 7 November, just after the elections.

In Europe, euro-denominated bonds are also offering stable yields. Business surveys are sending out a mixed message. The PMIs show a fall in manufacturing activity in April, but a strengthening in services. While Germany’s IFO business climate index showed an improvement, the European Commission’s survey showed a slight deterioration attributable to the sluggishness of the secondary sector.

ECB Vice-President Luis de Guidos confirmed the prospect of a rate cut in June, presented as a “fait accompli” in the absence of any unpleasant surprises. In this respect, the latest inflation figures published in Germany and Spain are moving in the right direction. However, the central banker was cautious about the next steps in the programme, which will depend in part on the choices made by the Fed. In the United Kingdom, the Bank of England’s chief economist dampened hopes of a rapid change of course, leading to a rise in sterling yields.

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