Blog

Rising Rates: Not So Fast

A variety of factors will likely limit the scope for rates to rise significantly.

Worries about rising U.S. interest rates have gripped global financial markets in recent weeks, with investors questioning whether the era of historically low global interest rates will persist.

Our view: Yes, it will. Despite the latest uptick in rates, we believe our New Neutral thesis – which holds that economic and demographic factors will weigh down equilibrium interest rates – remains the appropriate framework for valuing fixed income assets.

Policy rates are likely to stay lowest in Europe and Japan, with the European Central Bank and the Bank of Japan likely to keep their rates around zero for at least several more years.

As for the U.S., we believe a tight labor market will compel the Federal Reserve to stay on a gradual rate-hike course, placing continued upward pressure on market interest rates. Nonetheless, much of this story has already been written, and there is limited scope for rates to rise significantly further owing to a variety of potent factors.

Decision point

All of that said, global bond investors are near a “decision point” on whether the Fed will end its rate-hike cycle when the federal funds rate nears 2.875%. For about three years, the bond market has viewed this level as the terminal rate, implying an increase of about 75 basis points from today’s rate. Accordingly, for Treasury yields to move meaningfully from current levels, investors would have to expect either a higher or lower terminal rate for federal funds.

This decision point is why somewhat higher rates are plausible. Investors may have confidence in the Federal Reserve’s projection that its policy rate will peak at 3.4%, leading the Fed to push Treasury yields up to that level or a bit higher. Moreover, as we mentioned in our March outlook, “The Beginning of the End?” the neutral policy rate is an anchor and not a floor or a ceiling.

Nonetheless, in our most recent Cyclical Outlook, “Growing, But Slowing,” we project the Fed will increase its policy rate to a range of between 2.75% to 3.00% by the end of 2019, a benign outcome. We believe the anchors to The New Neutral framework remain firmly in place, in particular demographic influences such as the aging of the Baby Boomers, which will impair U.S. growth potential into the 2030s. Also at play are slow increases in investment and infrastructure spending, two major negatives for productivity growth. Rounding out the argument is the slower-than-historical pace of credit creation, a high global savings rate, and cautious consumer spending.

Broader market implications

Investors confused by the combination of falling equity and bond prices should consider many of the late-cycle dynamics – as discussed by Mihir Worah, CIO Asset Allocation, in “Late-Cycle Investing” – that can affect their portfolios, and weigh increasing their focus on risk factors such as equities, interest rates, volatility, and liquidity, building portfolios from the bottom up rather than seeking pure equity and credit beta.

In sum, while many factors can presage a bull-market-ending economic recession, high global interest rates are not likely among them. Yet for economies that today are inherently fragile, any tilt away from the extraordinary low-rate era can prompt quakes now and then.

Enjoyed this article? Subscribe to receive updates to the PIMCO Blog.

SUBSCRIBE
The Author

Tony Crescenzi

Portfolio Manager, Market Strategist

View Profile

Latest Insights

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

Looking Beyond Market Stabilization to the Future Path of Monetary Policy
XDismiss Next Article
PIMCO

LU

unidentified

[change]

Subscribe
Please input a valid email address.