Eurozone finance ministers, emerging market investors and owners of high yield corporate debt are arguably more concerned than most at present about the likely timing of what would be the US Federal Reserve’s first increase in interest rates since 2008. The strength of the US recovery will prove a determining factor.
And so far it has been a mixed but improving picture. A poor start to the year for the US has given way to a strong second-quarter bounce as inventories have been rebuilt.
Home construction surged in July to its highest level since November, but whether such growth is sustainable if rates start to rise remains an open question.
On the employment front, the US economy last month created fewer jobs than economists had forecast and the unemployment rate ticked up. It was, though, the sixth straight month in which employment expanded by more than 200,000 jobs.
These different signals appear to be sparking debate at the Fed. Chairman Janet Yellen commented in July that “labour market indicators suggest there remains significant under-utilisation of labour resources”.
Yet St Louis Fed president James Bullard, a member of the central bank’s rate-setting Federal Open Market Committee, told the Financial Times only recently that he believes an improving job market will force the Fed to review its policy statement on the economy, including its pledge not to change rates for a “considerable time” after its bond-buying scheme ends.
When the International Monetary Fund cut its global growth forecast in April to 3.4 per cent from 3.7 per cent, it said the global recovery was still not very strong, citing particular weakness in Latin America.
Yet the IMF also highlighted the economic upturn in countries such as the US and the UK where it said the recovery was resilient enough for planning to start on monetary policy “normalisation”, even if it was too soon to implement it.
As economists, bankers and policymakers debate interest rate policy, others look on with concern, fearing that any tightening in the US could only have negative consequences – perhaps no more so than among the fragile economies of the eurozone.
Here, the economy is at a different stage in its economic cycle, with inflation at its lowest for four years.
Sentiment in the eurozone was recently dented by concerns of systemic risk to the financial sector as the Espírito Santo family group, Portugal’s last surviving banking dynasty, collapsed following apparent accounting irregularities at Espírito Santo International, its Luxembourg-based parent company. This is a timely reminder that the single currency area remains fragile and its underlying structural problems have yet to be resolved.
Elsewhere, geopolitical tensions continued to escalate during July, not only in Ukraine following the tragic fate of the Malaysian Airlines flight MH17 but also in the Middle East. Global investors have in the main remained pretty sanguine and in the US the S&P 500 equity index has continued to climb, passing the 2,000 mark for the first time.
Emerging markets, though, could be seriously rattled by any concrete signal from the Fed of an imminent rate increase, especially if the “taper tantrum” of 2013 is anything to go by.
Meanwhile, high yield corporate debt looks a little vulnerable to interest rates going up in the US and this is why we believe it is so important to ensure we only have exposure to global bond managers who have plenty of scope to alter asset allocation and portfolio duration.
John Chatfeild-Roberts is chief investment officer of Jupiter Asset Management