Invesco Canada blog

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Brian Schneider | July 4, 2017

Interest-rate outlook: Expect rising rates in Canada

In June, Canadian 10-year government bond yields bounced off their lowest levels of the year, to 1.63%, as first quarter growth came in above expectations and central banks express confidence that monetary policy has accomplished it’s goal.1 The Bank of Canada (BoC), in particular, is less worried about uncertain U.S. trade policy and another substantial drop in oil prices, and becoming worried that excess capacity is beginning to dwindle. Their optimism may prove to be premature as inflation remains very low, so we are watching its stance closely. We expect interest rates in Canada to rise from current levels.

Below is the latest outlook for global interest rates from the Invesco Fixed Income team.

United States

U.S. inflation data surprised to the downside for the third month in a row. While we expect U.S. growth to continue at a solid pace, inflation is likely to stay low for the next several months before moving higher in 2018. We do not expect the downside surprise in inflation to delay the beginning of the Federal Reserve (Fed) plan to begin reinvestment tapering in September. However, the future inflation readings will be critical in determining when the Fed raises the federal funds rate again. If inflation stays low, this may not occur until the middle of 2018.

Europe

We remain negative on our outlook for core European fixed income as the European Central Bank (ECB) is now acknowledging the economic recovery taking place in the eurozone and that policy must be adjusted accordingly. We prefer to focus our short positions on the 10-year part of the yield curve. The fact that the ECB is ready to move despite a lack of wage inflation has caught the bond markets by surprise and could pressure long-held core bond positions.

China

The onshore Chinese government bond (CGB) yield curve inverted in May, as shorter-term bonds underperformed longer-term bonds amid tighter short-term liquidity conditions. However, this inversion reversed after the Ministry of Finance purchased one-year CGBs for the first time in June. We think this move sends an important signal about the government’s role in managing the CGB yield curve. As financial deleveraging continues, we expect broad credit growth to slow in the third quarter. This will likely have a negative impact on economic growth in the second half of this year. We believe short-term government yields may still be subject to interbank liquidity fluctuations, but we expect longer-term yields to be more stable and outperform in the second half of 2017.

Japan

The Japanese economy continues to experience growth in excess of its potential, driven primarily by a pick-up in consumption, and unemployment has declined to 2.8%.2 Wages must continue to increase if this momentum is to be maintained going forward and Prime Minister Abe will likely encourage this trend. The improvement in the Japanese economy has not gone un-noticed. The International Monetary Fund recently described Abenomics as a “success.” It did, however, warn against fiscal tightening and an exit from monetary easing. In terms of the latter, we expect the Bank of Japan to keep policy unchanged for the time being, although it will likely continue to quietly taper asset purchases, should conditions allow.

United Kingdom

The U.K. general election outcome in June took everyone by surprise. What was expected to be a one horse race turned into something much closer. So close that the Conservative party lost its outright majority in Parliament and only maintained control by teaming up with the Democratic Unionist Party. Coalitions with such a slim majority have not traditionally fared very well in the U.K., with many holding together for less than a year. If Prime Minister May is to buck this trend, she will need to compromise more than she has in the past, not only with opposition parties, but also with her own members of Parliament.

This could prove to be untenable and a leadership challenge or another election this year cannot be ruled out. In the shorter term, we expect many of the pre-election manifesto pledges to be downplayed and for there to be a far more conciliatory approach towards Brexit discussions. These talks are likely to be fractious in the early stages, but we expect cool heads to prevail in the longer term with the U.K. agreeing to a softer Brexit at worst. The probability of the U.K. remaining in the EU is also likely to increase. We expect the Bank of England to keep interest rates on hold and for gilts to underperform U.S. Treasuries in the near term.

Australia

The Reserve Bank of Australia (RBA) held its benchmark interest rate steady at 1.50% as expected at its June 6 meeting. The statement was rather upbeat about the economy’s prospects but conceded that first quarter growth would be weak. The unemployment rate fell to 5.5% in May, which is a new cyclical low.3 The RBA continues to be concerned with the leverage-driven housing market. While this concern will likely keep the RBA from lowering interest rates, stubbornly low inflation should keep hikes off the table as well. We remain neutral on Australian interest rates because we believe the RBA will be on hold for the foreseeable future.

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1 Source: Bloomberg L.P., June 19, 2017.

2 Source: Ministry of Internal Affairs, May 29, 2017.

3 Source: ABS, June 15, 2017.

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