FYI | Jun 01 2007
By Chris Shaw
The US housing market is weak, inflation has come down a little over the past few months and growth in the first quarter this year was softer than expected, so the next move in US interest rates will be down.
This is a view shared by TD Securities, but following a visit to a number of fund managers in the US the group’s global strategist Stephen Koukoulas has pointed out there remain a number of risks to this view actually proving to be correct.
Firstly, while US GDP was weak in the March quarter a rebound to a growth rate of around 3% is expected for the quarter to June, meaning growth is actually not too bad. A rebound is also likely in the housing market in coming months as eventually demographics will come to the rescue given the US is experiencing population growth of the order of three million people annually and these people will lift demand for housing.
At the same time, while inflation has come down from its highs it remains above the Federal Reserve’s comfort level, meaning rates are unlikely to head lower until inflation falls further. Supporting such a steady as she goes approach is continued strength in equity markets, as Koukoulas notes the Fed has a history of not cutting interest rates at the same time as the stockmarket is moving higher as a stronger equity market is indicative of rising corporate profits and solid activity levels.
While not directly comparable Koukoulas also points out the Canadian economy is very strong and has been even as the US economy has weakened, a factor some argue is indicative of the US economy being somewhat stronger than the official data would suggest.
So while the market is factoring in rate cuts in coming months Koukoulas notes there are a growing number of market participants who suggest the market in fact has it wrong and the risks to US growth are actually to the upside, meaning the risk to rates is also to the upside.
Comments by Federal Reserve members seem to support such a view, as Koukoulas points out to date not one member has argued rates need be lower but a number are still commenting on the risks inflation poses to the economy overall.
Koukoulas’s conclusion is rates are at best likely to remain on hold for another six months or so, meaning conditions are somewhat bearish for yields in the bond market as there will need to be an adjustment given the market has priced in a cut in coming months.