The pre-crisis norm was 4.5 per cent. Even after rate hikes start in 2015, they are expected to remain gradual and limited, such that they will only reach 2 per cent in mid-2018.
In contrast the eurozone curve is pricing rates to remain below 1 per cent until 2020 while the US curve is steeper than that of the UK, with rates expected to be about 3 per cent in 2020.
Accommodative monetary policy in the major advanced economies has helped to dampen volatility and we have seen investors take on additional risk in search of better returns.
However, if the US Federal Reserve raises rates earlier than market participants expect, volatility levels could increase. And even if rates only rise in line with market expectations, there is still a risk that markets could react badly and there is a repeat of the “taper tantrum” that occurred in mid-2013.
This would hit emerging markets hard, although we would argue that they are generally better placed now than a year ago to withstand shocks. Markets are also now more likely to differentiate between stronger and weaker emerging economies than was the case in mid-2013 and again in early 2014.
On this basis, the peripheral eurozone economies will be better shielded from market volatility due to the ECB loosening its policy to ward off the spectre of deflation and stimulate economic growth.
If major central banks tighten too gradually and too late, this risks the creation of asset bubbles that would force a severe economic adjustment.
Where could we go from here?
The continued distortion of asset prices by policy actions makes having a strong conviction around fundamental indicators challenging and the winding-up of several years of highly accommodative monetary conditions is unchartered territory. In addition, the potential for a ‘hard-landing’ in China, as its growth rate slows, adds an additional layer of complexity.
While, of course, the debate around market expectations of interest rates is a complex one and is not something that fund managers or investors can control, its impact on asset return assumptions makes it an important consideration when setting long-term investment objectives.
Andy Brown is investment director of Prudential Portfolio Management Group
Key points:
The ‘lower for longer’ interest rate environment we currently find ourselves in has some profound implications for investors taking a long-term outlook.
It now looks likely that the US Federal Reserve will be the first of the major advanced economy central banks to hike rates, probably around mid-2015.
If the US Federal Reserve raises rates earlier than market participants expect, volatility levels could increase.
