Date
28 May 2017
Economic risks may increase if the rise in interest rates is postponed too long, as overheating in the economy might result, Janet Yellen says. Photo: Bloomberg
Economic risks may increase if the rise in interest rates is postponed too long, as overheating in the economy might result, Janet Yellen says. Photo: Bloomberg

Three lessons from history not to be forgotten

Global markets have corrected a bit, especially in Europe, partly owing to disappointment over central bank policies.

The market’s focus now is on the US Federal Reserve’s meeting next week, at which it will discuss raising interest rates.

Fed chairwoman Janet Yellen said last week in Washington that economic risks may increase if the rise in interest rates is postponed too long, as overheating in the economy might result.

It is believed that the Fed would rather not take this risk, so it is is essential for a “normalization” of interest rates to start this month.

November employment data from the United States shows the economy is on a moderate recovery path; however, inflation remains relatively weak.

So, the market doesn’t have to worry about a significant rate hike.

A rate hike would remove at long last the uncertainty around the interest rate outlook and potentially lead to better market performance.

Recent data shows that the equity and corporate bond markets have performed well as the expected rate normalization approaches.

Yellen’s words reminded us about three lessons from history:

(1) Equity and corporate bond markets responded positively after a first hike in interest rates.

On average, most equity markets reported a weak performance in the first three months after an interest rate rise but rebounded significantly within six months.

(2) Most stock markets recorded positive returns.

European markets outperformed those of most other regions.

Asian stock markets diverged during the interest rate raising cycle.

So we remain conservative about whether Asian stock markets will outperform the average.

Meanwhile, the Indian stock market stayed relatively stable.

(3) High-yield corporate bonds and US dollar-denominated treasury bonds in emerging markets performed better than other bond categories. So did senior loans.

The European Central Bank announced last week it will extend its quantitative easing measures until March 2017.

However, the smaller than expected scale of the measures created downward pressure on stock markets and led to an increase in the exchange rate of the euro against the US dollar.

I believe the response is just temporary and that quantitative easing, negative interest rates and the expanding discrepancy between the interest rates of US treasury bonds and those of European countries will support the European stock markets, on a currency hedging basis, and will lead to a further decline of the euro-to-US dollar exchange rate in the coming year.

This article appeared in the Hong Kong Economic Journal on Dec. 10.

Translation by Myssie You

[Chinese version中文版]

– Contact us at [email protected]

MY/DY/FL

head of private banking and trust services at Hang Seng Bank

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