The FTSE 100 marked time for another week after comments from Mark Carney that the UK economy will grow faster than anticipated and the unemployment rate could fall below the Bank's target of 7% towards the end of next year, 18 months earlier than previously forecast. This led to expectations interest rates could rise sooner than expected. On the other side of the pond the incoming Federal Reserve Chairman seemed to indicate that tapering the bond purchases was not high on her agenda. In contrast to the muted reaction of the FTSE 100 the S&P 500 reached new highs. Interest rate expectations dominate economic commentary. In the weekend press the Sunday Telegraph markets section headlined, interest rates are going to rise- it's better to prepare now. The Sunday Times economic editor headlines, bank rates won't be lifting any time soon.
Both writers agree rates will rise one day, for no other reason than they are at historic lows. The logic cannot be faulted, the debate is when and what will be the effect on risk assets? The Sunday Times article points out that despite the improving economy, and the creation of over 350,000 jobs in the UK in the past year, the unemployment rate has remained static at about 7.5%. In their view rates, despite the improving economic outlook for 2014, will remain at these lows for at least another 2 years. The message from the Telegraph seems a little more confused, but offers advice as to what assets do well in a rising rate environment.
The point I agree with and think will be the focus of both central banks is inflation expectations, at present no one seems to see the spectre of inflation on the horizon. In the euro zone they are suffering the other problem, fending of deflation.
I have often speculated that the Fed could start tapering as the ECB starts to expand their balance sheet, if that were to be the case the dollar could rise sharply particularly against the euro. Fears would then be raised on the impact that would have on the US economy.
Interest rates around the globe will need to rise one day and it will be in reaction to an economic recovery. The normalisation of rates could take many years and equity markets will need to adjust as they do. Good companies do well in most interest rate environments, but we could be entering a period of recovering economies and interest rates remaining low relative to history, should this be the case it will provide a decent back drop for equity markets in the coming years.