On August 4th, the Bank of England (BOE) cut interest rates for the first time in seven years. The move came in response to economic concerns following Brexit as the BOE lowered its economic growth expectation for 2017 from 2.3% to 0.8%. The full BOE package includes: 1) cutting its Base Rate by 0.25% to 0.25%, a new record low 2) the expansion of quantitative easing by purchasing £60 billion of Gilts (UK government bonds) and £10 billion of British corporate bonds 3) introduction of a £100 billion Term Funding Scheme to lend cheaply to banks, with the goal that they issue low cost loans to the marketplace.
The Bank of Japan’s core inflation gauge, CPI ex-fresh food, declined 0.5% in July. This marked the fifth consecutive month of negative year over year inflation in Japan and the most negative inflation reading since March 2013. There have been no positive inflation readings in 2016 and the last time Japanese inflation exceeded 0.5% was the first quarter of 2015. The continued weak inflation situation raises expectations of additional monetary accommodation from the Bank of Japan, which next meets September 20-21.
European inflation of 0.2% for August matched last month’s level, according to Eurostat, and did not meet expectations of a 0.3% increase for the past year. Core inflation, excluding food and energy, rose 0.8% for the past year, a decline from last month’s level of 0.9%. The European Central Bank’s (ECB) quantitative easing program was originally scheduled to run through September of 2016, before being extended through March of 2017. With continuing low inflation in Europe, the possibility of increased policy easing persists. The next ECB Governing Council meeting on September 8th is being watched for indications of additional monetary stimulus.
After skipping the event last year, Janet Yellen delivered a speech at the Fed’s Jackson Hole Economic Policy Symposium on August 26th. Regarding policy normalization, she indicated that “the case for an increase in the Federal Funds rate has strengthened in recent months.” These remarks lifted expectations for a near-term rate hike, possibly including the September 20-21 Fed meeting. Fed Fund futures currently imply a 36% probability of a rate hike in September and a 60% probability of a hike by December.
In the past, the symposium has been a venue for the introduction of new central bank policy leading to high anticipation of her speech. In terms of potential new policy, Chair Yellen offered that the Fed had additional tools at its disposal to ease policy aside from rate cuts as the Fed Funds remain below the long-term target. She eschewed new policy prescriptions for the time being, while suggesting new monetary policy tools were subjects for additional research. Among those tools were the expansion of eligible assets for the Fed balance, currently in use by other major central banks.
Earlier in August, Fed minutes from the July meeting were released. Of note in the minutes, some members believed that “another increase in the federal funds rate was or would soon be warranted” and one member voted for a rate hike at the July meeting.
In our view, between the Bank of England’s recent easing and expectations of central bank policy based on recent global economic data, policy divergence appears to be widening between the U.S. and other developed markets. Further, with multiple central bank meetings in September, the potent exists for the already sharp differences to be amplified. While markets do not currently project a Fed rate hike, the U.S. conversation remains around the timing of the next step in normalization. The U.S. discussion stands in stark contrast to that in Europe and Japan, which may further ease monetary policy in their continuing battle against persistently low inflation. High quality U.S. fixed income, already supported by U.S. fundamentals, continues to be bolstered by differences in global monetary policy making the U.S. rate environment more attractive and continuing to attract attention and capital from overseas.
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