Future of interest rates still uncertain - 16 October 2023
Rising oil prices and discouraging US inflation figures have reignited fears of a negative scenario for the financial markets. Having said that, the future of interest rates is still fairly uncertain.
Since the end of July, investors’ concerns have centred around what a “higher for longer” interest rate scenario would mean. Indeed, the labour market’s resilience and the fact that inflation is unlikely to fall back to its famous 2% target any time soon have made the prospect of rate cuts seem further off, which has boosted bond yields. On the face of it, this risk scenario does appear more likely due to renewed upward pressure on oil prices and persistent US inflation in September – the Consumer Price Index (CPI) excluding food and energy rose 0.3% for the second month in a row (cf. chart 1).
However, there many reasons to believe that, although risks are on the rise, the outcome is complex and therefore not set in stone. First of all, US inflation in September was predominantly boosted by a rather surprising and probably temporary increase in rents, which account for 44% of core CPI. Moreover, we will need to wait until the end of the month to find out the other key inflation figure for September, the Personal Consumption Expenditure deflator, which is preferred by the Fed and has a different composition to the CPI. In August, the two statistics painted two different pictures, with the deflator ultimately proving more accurate than the CPI.
It is therefore not yet a given that the Federal Reserve will decide to raise its interest rates again on 1 November. Recent remarks from certain Fed officials, suggesting that the surge in long-term yields since its last meeting in July reduced the need for further monetary tightening, have clouded the picture still further. Finally, the Israeli-Palestinian conflict has brought some safe-haven assets, including long-term bonds, back into fashion. Real interest rates have declined in recent days (cf. chart 2).
Amid this complex environment, we are maintaining a neutral allocation of equities in our global diversified portfolios and have shifted to a positive, yet still relatively low, bond duration. Money market instruments continue to be the main driver of regular returns.