Expect higher rates by June: economist

Singapore

THE market has underestimated the pace of higher interest rates in the US, with the first hit expected around June rather than in the second half of the year, as some expect, says Bank of Singapore chief economist Richard Jerram.

This sets the stage for some volatile swings in the equity markets, noted panellists from OCBC at a seminar for its premier banking clients, though markets may turn calm within 6-9 months from the point of the rate hike, with investors adjusting as they did after previous rate boosts.

Economic growth in the US - the fastest in 10 years - stands apart from the subpar growth in Japan and the eurozone, said Mr Jerram on Tuesday. The rate of unemployment in the US is also improving, with the country some 6-12 months away from full employment on a statistical basis, he added. Last November, US unemployment stood at 5.8 per cent.

"I'm not sure the market appreciates how far behind the curve they are, and deliberately so," said Mr Jerram, referring to the Federal Reserve. "I think they are already two years late in raising rates."

The Fed's delay in raising the interest rate - which has been near zero since December 2008 - comes as the labour participation rate is still at its weakest since the 1970s. The aim is likely to have the labour market tighten, leading to higher wages, and job opportunities. These should in turn draw in those who have left the job market, said Mr Jerram.

"It's quite a dangerous approach, because if you're wrong, if the drop in the participation rate is demographic, or social, then all you're going to generate is wage inflation," he said.

Wage inflation refers to the spiral effect when companies raise the prices of its goods and services to offset higher salaries. That then hits the real wage growth of employees overall, creating pressure for higher wages again. A lift in rates is meant to fend off inflation.

As it is, most research shows that the drop in the participation rate is not going to reverse, Mr Jerram added. Meanwhile, one lagging indicator of wage pressures - the employment cost index - has been rising. "That's suggesting that you're going to get that acceleration in wages," he said.

This also comes amid the "policy divergencies" in global economies, said Michael Tan, senior investment counsellor at OCBC. The eurozone is now fighting deflationary pressures and looking to lower rates via quantitative easing. In raising the supply of the euro, depreciation against the currency of another country occurs. All in, the US dollar will continue to strengthen against the euro, as well as the yen, said Mr Tan.

Investors also need to watch out for China's massive credit bubble - with borrowings at nearly double of its GDP; the emerging market average, in comparison, stands at 60 per cent. The silver lining is that this would be self-contained, said Mr Jerram.

While investors should buckle up for a bumpy ride, the volatility should ease in six months, said Hou Wey Fook, chief investment officer at Bank of Singapore. This was seen in 1994 and 1995, when the Fed raised rates and the market range-traded for several months before grinding higher.

The bank prefers developed markets over Asia, as this region is vulnerable to Western investors taking their funds back home.

In the US, technology and banking stocks should be good plays amid improving growth and benefits from rising interest rates, said Mr Hou. Back home, the Straits Times Index could see an approximate 10 per cent boost this year, as investors look to companies with a strong balance sheet, said Carmen Lee, head of OCBC Investment Research.