Few expect September US rate hike, but market risks are rising

Singapore

FINANCIAL markets are expecting only a 20 per cent chance of a rate hike to the 0.5-0.75 per cent target range at the conclusion of Wednesday night's US Federal Reserve meeting.

Most houses expect a December hike and analysts are highlighting rising market risks. These include a Fed signal of a December rate hike and non Fed-related risks such as the election of unpredictable businessman Donald Trump as US president in November.

Societe Generale's global head of economics Michala Marcussen said on Sunday that she expects the Fed to lower its long-run interest rate target from 3 per cent to 2.75 per cent.

But she noted that a Trump victory could lead to more US government spending, which will trigger higher inflation and, correspondingly, a steeper yield curve with a higher long-term interest rate.

The Bank of Japan is also due to release the results of a comprehensive assessment of its monetary policy on Wednesday, which might also affect how risky assets trade, she said.

DBS said in a Monday note that the market believes the Fed is not going to move because of conflicting messages from Fed officials, along with weaker US manufacturing, industrial production and retail sales data.

Yet, it said, there are reasons to be cautious. Asset markets face risks of a clear signal of a rate hike in the coming months, a historical tendency for equities volatility to rise in September to November, upcoming US elections, and expensive developed market valuations, DBS said.

Meanwhile, Citi Research noted on Monday that markets are only partially pricing in a Trump victory, even while polls show a tightening race.

Hillary Clinton might lead in the polls, but polling methods may not capture marginalised voters, it said. Citi reduced the likelihood of a Clinton win to 60 per cent from 65 per cent, with a 40 per cent probability of a Trump win.

Citi said: "Hillary Clinton still has a much more mathematically straightforward path to victory in the Electoral College vote, but suffers from an 'enthusiasm gap' that may affect support at the polls on Nov 8, with Trump voters significantly more likely to say they intend to vote."

A Trump win will lead to weaker global stocks, higher gold prices, weaker emerging market currencies and steeper yield curves, Citi said.

Bond markets, meanwhile, are warily watching the recent rise in longer-dated bond yields.

Yields on Japanese 10-year bonds, negative for much of the year, have spiked since the end of July; last week, they came within touching distance of positive territory.

The German 10-year bond, in negative territory since Britain's vote to leave the European Union in late June, managed to trade above zero last week.

Meanwhile, US 10-year yields have risen from around 1.5 per cent earlier this month to around 1.7 per cent now.

Joachim Fels, global economic advisor at bond manager Pimco, said on Tuesday that the summer lull in markets might be over as doubts rise over the effectiveness of low interest rates.

"Central banks, which have been dampeners of volatility ever since the 2008 crisis started, have all of a sudden become a source of volatility as they may be less willing to underwrite markets in the coming months.

"The fallout from Brexit looks contained and the long-term negative effects of extremely low interest rates on the financial sector are becoming ever more apparent."

Johan Jooste, Bank of Singapore chief investment officer, is a bit more sanguine. The year 2016 will be choppy but trendless, he said.

The recent spike in long-end bond yields is relatively modest, compared to the "taper tantrum" of 2013, he said. Then, the US 10-year yields almost doubled to 3 per cent within half a year.

Though further rises before the end of the year cannot be ruled out, the risk of a large and sharp move is contained in a low-inflation environment, he said.

In Asia, expectations for a longer rate hike cycle, better China data and more stable commodity prices have driven flows back.

While near-term risks to Asian stocks are rising from a steeper yield curve, the long-term environment remains supportive as interest rates remain low, said HSBC equity strategists in a note last Thursday.

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