Global events—including the United Kingdom’s vote to exit the European Union—are playing a greater role in driving all markets and economic policies than in the past. As a result, U.S.-based views of interest-rate normalization require revision. We’re focusing increasingly on global signals, as the Federal Reserve (the Fed) has done.
Read the full Q3 2016 CIO Insights Introduction:
The Economy Is Truly Global, as U.S. Fed-Watchers Keep Finding Out
Interest-rate normalization (higher rates) has been painfully slow. We’ve written extensively about how central banks—particularly the Fed—could/should be reversing the massive monetary stimulus unleashed after the 2008 Financial Crisis.
Since then, the Fed has raised its interest rate target once, by a mere quarter percent, and bond market expectations of further rate hikes have been mostly subdued. Meanwhile, interest rates in other leading developed economies have declined and even gone negative (see graphic below).
Besides higher interest rates, normalization potentially represented several changes, including less central bank control of economies and markets, more market risk, and greater divergence in investment returns. Normalization also reflected a view of the world that was relatively U.S.-focused, where the largest economy and its central bank would help lift the global economy as U.S. economic growth strengthened.
Instead, normalization has been delayed. Why? Primarily for global reasons, starting with China, the world’s second-largest economy and, until 2015, one of the fastest-growing. Growth problems in China have rippled through the global markets over the last two years, influencing commodity prices, emerging market growth, stock prices, relative currency values, and bond yields.
As shown below, the Fed is swimming upstream against global interest rates. The Fed is in a very difficult position—after its rate increase last December, stock and high-yield corporate bond¹ markets sold off globally in January, leading other central banks to add more monetary stimulus. The Fed fears this could happen again.
In our expanding economic and financial world, global macro factors are increasingly driving Fed decisions and capital market behavior. This builds the case for professional resources such as our Global Macro Strategy Team, which provides guidance for our investment decisions. The team’s views are published in our quarterly Investment Outlook. We’re increasingly looking for signals and opportunities outside the U.S., a key part of a process that we believe is essential to diversification and other portfolio risk-management strategies.
¹High-yield corporate bonds are higher-risk, high-yielding taxable bonds comprised of debt instruments from corporations rated below BBB-by Standard & Poor’s.
Diversification does not assure a profit nor does it protect against loss of principal.
Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.
The opinions expressed are those of G. David MacEwen and Victor Zhang and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.