FYI | Jan 10 2007
By Chris Shaw
For the last few months bond markets have been pricing in an easing in interest rates in the US, but as the Dow Jones Index has recently recorded a series of record highs and unemployment is low and moving lower, is such an easing likely?
According to TD Securities such conditions don’t preclude central banks from moving to lower official interest rates, especially given central banks are now more focused on pre-emptive moves. It suggests though such a pre-emptive move is likely to limit the extent of any easing cycle
The broker notes historically there is a solid link between the commencement of an interest rate cutting cycle and lower share prices and higher unemployment, as the move on rates is an attempt to limit the scope of any economic downturn for which equity prices are a leading indicator and the unemployment rate a lagging indicator.
This suggests an easing cycle in the US and Canadian markets could well begin in the short-term, hence the move by bond markets to price in such an outcome. Supporting this view according to the broker is the recent soft GDP data, which could flow through to weaker labour market conditions and corporate earnings in coming months.
Such an outcome fits with the broker’s forecast, which is for rates to begin coming down in the US in March, coinciding with an increase in the unemployment rate to around 5.2% by the end of the year.
A similar outlook is in place for Canada, the broker anticipating the first cut to official rates to be in April and for inflation to trend gently higher over the course of 2007. Both cycles should be moderate though, the broker expecting only 0.75% of cuts to official rates in the US and 50 basis points in Canada as historically pre-emptive moves on rates have coincided with moderate easing cycles.