No interest rate hikes on horizon - at least for now

The fragile tone to sentiment on financial markets this year has carried over into May.

Disappointing survey data out of China and the UK, as well as some weak US economic figures, have done little to ease concerns about the slowdown in the global economy.

As a result, risk aversion has been very much in evidence on financial markets in the past week.

The Euro Stoxx 50 equity index fell by over 3% last week and is down around 10% year to date.

US equities have also suffered, although to a lesser extent, with the S&P 500 just about in positive territory since the start of the year.

The continuing concerns about the outlook for global growth are also reflected in bond yields, which remain anchored at very low levels.

Indeed, in the past week, the yield on 10-year US Treasuries dropped back below 1.8%, while the yield on 10-year UK gilts was down around 15 basis points on the week to near 1.45%.

It is not just traders and investors who are concerned about developments in the global economy.

So too are the main central banks, which have adopted a much more cautious approach and tone in regard to monetary policy in recent months.

Last week saw a surprise rate cut from the Reserve Bank of Australia, even though growth is holding up reasonably well in that economy.

This follows rate cuts in China, Japan and the eurozone earlier in the year, as well as policy easing by a number of other smaller central banks.

Meanwhile, central banks that had been expected to hike interest rates are showing a marked reluctance to do so.

In the UK, where the unemployment rate has fallen to 5.1%, the Bank of England is very much on hold. It is likely to again keep rates at 0.5% when it meets later this week.

This is not that surprising given the uncertainty about the upcoming referendum on EU membership on June 23. This is beginning to weigh on economic activity.

What is surprising, though, is that markets do not expect a rate hike in the UK to materialise until the second half of 2018.

Turning to the US, the Federal Reserve indicated when it hiked rates in December for the first time in nearly a decade that this was likely to be the start of a long series of rate increases.

However, it has backed off implementing any further rate increases since then.

It comes amid mounting concerns about the downside risks to global growth, with the pace of activity in the US also slowing in recent quarters.

Now markets do not expect another hike in US rates to materialise until well into 2017.

Furthermore, they do see Fed rates getting up to 1% until the end of 2018. Only last December, the Fed’s own forecasts had suggested that rates were likely to rise to a 3% to 3.5% range by then.

The scaling back on interest rate hike expectations in the US is having quite a negative impact on the dollar.

Both the euro and yen have made significant gains against the US currency in recent months even though the ECB and Bank of Japan have cut interest rates this year.

The euro has risen from $1.08 to $1.15 against the dollar since January. The performance of the Japanese yen is even more impressive, with the dollar falling from ¥122 to ¥106 in the past four months.

The dollar has fallen from $1.45 to below $1.30 against the Canadian dollar over the same period.

Thus, the strong appreciation of the dollar witnessed in 2014 and 2015 has come to a halt. Overall, on a trade-weighted basis, the dollar has lost around 5% in value since the end of January.

However, it is too early to signal that the uptrend in the dollar is at an end.

There are already some signs that activity in the US economy may be regaining momentum.

Wage growth has also started to pick up, while inflation is beginning to accelerate.

These trends, if sustained, could well bring rate hikes back on to Fed’s agenda later this year, pushing the dollar upwards once more.

Oliver Mangan is chief economist at AIB.