Last night Congress asked the Fed to discuss 'negative interest rates'
Janet Yellen, Chair of the US Federal Reserve (Fed), gave her testimony to the US Congress last night, as the Chair does routinely every six months. What was unusual on this occasion was the discussion around 'negative interest rates'. It came up from Congress, not at Yellen’s will, but the point is that Congress is asking the Fed its views on whether the US could implement negative interest rates like those used in Europe and Japan.
That interaction paints the picture about how much has changed in the broader market’s view of the global economy since December last year. In December, the Fed put up rates for the first time in nearly 10 years and most commentators, including anyone from Congress that had a chance to speak, said it was 'about time' or 'too late'. Less than two months later and Congress is asking about negative interest rates and the market has priced in no increase in rates until 2017. That’s a far cry from the Fed’s own prediction of four rate increases in 2016.
The rest of Yellen’s speech was more interesting for its tone. She was balanced, but decidedly more concerned about world growth and in particular market volatility than in any other speech since 2012. She said 'I do not expect the FOMC (Fed) is going to be soon in the situation where it’s necessary to cut rates', going on to rightly point to the fact that US wage growth, an indicator of economic health, was finally starting to show some growth. She did point out however 'tightening financial conditions driven by falling stock prices, uncertainty over China and a global reassessment of credit risk could throw the U.S. economy off track from an otherwise solid course.' Similarly, she talked about the self-reinforcing nature of global economic weakness. Starting from an oversupply in manufacturing capacity and weak commodity markets rattling confidence about demand growth, which only reinforces the slowdown in business investment.
Bond rates have fallen very quickly in the US, but strangely not as fast in Australia. Australian five year government bond rates are down 28 basis points (bps) in the past month to 1.91% p.a. while the US equivalent is down 39 bps to 1.21% p.a. Yet with the global concerns linked mostly to the Chinese economy dragging down world growth, it is Australia that will suffer far more than the US. The US economy has strong business investment and consumer spending growth, while Australia’s remains patchy. And, the US economy is far more self-sufficient, while Australia’s is one of the most China-dependent economies in the world.
There are currency flows, particularly involving Japan, that are likely to be driving this short-term mismatch with fundamentals, in our view. Investors should consider opportunities to lock in higher rates in Australian bonds while this lasts. Once the world markets rebalance and align around an outlook of lower for longer economic growth, Australia’s economic prospects could be downgraded and then Australian yields will fall (increasing the prices of our bonds).