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US inflation stirs global rate rise bets – The Australian Financial Review

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Pedestrians walk along Wall Street in front of the New York Stock Exchange (NYSE) in New York.

Global investors are positioning for higher central bank interest rates as firming US inflation and robust consumer spending pushed the yield on the two-year US Treasury bond above 2 per cent for the first time since the 2008 global financial crisis.

US Federal Reserve officials and economists on Wall Street ramped up warnings that the accelerating US economy might overheat as President Donald Trump’s tax cuts kick in, setting the scene for the Fed to steadily raise interest rates in 2018.

The Bank of Canada is this week expected to increase interest rates for the third time in six months. The Bank of Japan last week trimmed its bond purchases and the European Central Bank hinted the stronger euro zone economy may allow it to dial back asset buying.

The anticipated gradual withdrawal of monetary stimulus in response to an accelerating world economy leaves the Reserve Bank of Australia isolated compared to other central banks. The RBA hasn’t publicly signalled a looming rate rise.

“There is definitely a trend towards a more hawkish tone from developed-market central banks; the only exception is the RBA,” said Macquarie Group global interest rates and currencies strategist Thierry Albert Wizman.

Higher US inflation was raising new concern, he said.

“The US stock market is on fire, oil prices are higher, commodity prices are higher and minimum wage increases are taking place in the US in January.

“This may prompt the Fed to sound more hawkish in January.”

Wall Street rally

Shares on Wall Street rallied to another record on Friday, lifting the S&P 500 4.2 per cent so far in 2018, the best start to a year since 2003.

The Australian sharemarket, which has lagged overseas rivals so far this year, is set to start the week sharply higher on the back of the Wall Street rally.

Over the weekend ASX futures surged 31 points or 0.5 per cent while the Australian dollar topped the US79¢ mark as the greenback swooned.

Two Fed board members warned last week there was a risk the US economy could overheat as tax cuts take effect this year.

RBC Capital Markets chief US economist Tom Porcelli said the “risks of overheating is the next big debate at the Fed”.

“The Fed went into 2018 with a base case of three hikes for the year,” but “they must hike in March and June in order to have the option to go four times this year if need be”, he said.

Data on Friday showed the US core consumer price index (CPI) – which excludes volatile energy and good prices – accelerated at a faster-than-anticipated 0.3 per cent in December to be up 1.8 per cent for the year, approaching the Federal Reserve’s 2 per cent target.

Headline CPI, which the Fed pays less attention to, rose 0.1 per cent for the month and was up 2.1 per cent in 2017.

Improving growth

American consumers opened their wallets in the lead up to Christmas before Mr Trump’s tax cuts took effect in 2018.

Retail sales jumped 0.4 per cent in December and November sales were revised up to a rapid 0.9 per cent. 

“The improving labour market, robust consumer confidence and the imminent boost to disposable incomes from the recently-enacted tax cuts suggest that spending will continue to grow at a healthy pace over the first half of this year,” said Capital Economics US economist Andrew Hunter noted.

The US jobless rate is a low 4.1 per cent and the economy is on track to record its third straight quarter of above 3 per cent growth.

The yield on the two-year US Treasury note, a leading indicator for market bets on Fed interest rates, rose on Friday to 2.02 per cent, a level not seen since the collapse in yields around the time of investment bank Lehman Brothers’ bankruptcy in September 2008.

Government bond yields around the world jumped last week. Investors ditched fixed income securities, on signs the world economy is growing faster and central banks intend to dial back their unprecedented stimulus.

Boosting inflation expectations, the price of oil notched a three-year high, with the global benchmark, Brent crude, hitting $US70 a barrel and America’s West Texas Intermediate selling for $US64.

Despite moderately rising US inflation and higher bond yields, the US dollar index declined to a three-year low against a basket of currencies due to the ECB inferring on Thursday it may begin paring backs its asset purchases a few months earlier.

‘We’re going to overshoot full employment.’

The Bank of Japan last week trimmed its purchases of government bonds.

“It seems that we are getting almost daily reminders that key global central banks are about to change policies,” Bank of America credit strategists Hans Mikkelsen and Yunyi Zhang wrote in a research note.

The Australian dollar rallied to break above US79¢ for the first time since September, even though the RBA is one of the few central banks not to signal a potential tightening of policy is on the horizon any time soon.

The weakening greenback gives the US Fed more room to raise interest rates, economists said.

The Fed has projected three interest rate rises this year. Non-voting Dallas Fed president Robert Kaplan said on Friday this was his “base case”.

“I have more conviction that we’re going to get down into the 3s in terms of headline unemployment,” he said on CNBC.

“We’re going to overshoot full employment.

“The history of overshooting full employment in this country has not been a happy one.

“Normally, what happens is you get an overheating, the Fed has to play catch-up, and what happens then is you tend to often have a recession.”

‘Risk of a hard landing’

New York Fed president William Dudley said last week even though US inflation was low there was a risk the economy could “overheat” due to the combination of above trend economic growth, low unemployment, loose financial conditions and the $US1.5 trillion Republican tax cut.

The Fed “may have to press harder on the brakes at some point over the next few years”, which increases the “risk of a hard landing”, he said.

Most economists are tipping incoming chair Jerome Powell will announce in March an increase to the current 1.25-1.50 Fed funds target range.

There is an earlier meeting likely to be led by outgoing chair Janet Yellen on January 31 if Mr Powell is not  confirmed by the Senate by then, though Fed funds futures are pricing in only a 1.5 per cent chance the Fed hikes this month.

“As we turn the page to 2018, there are a few obvious clouds on the horizon for the world economy,” FIS Group chief investment officer Tina Byles Williams said.

“Nonetheless, we expect 2018 to be a transition year. Stretched valuations and extremely low volatility imply that risk assets are vulnerable to the consensus macro view that central banks will not be able to reach their inflation targets, even in the long term.”