But, of more import to bond investors is what this all will mean for bond prices and yields going forward.
Chris Iggo, CIO fixed income at AXA Investment Managers says that while the signal is clear, it does not necessarily mean the UK is yet significantly closer than it was previously to a higher rate regime. While, across the pond, he says, much of debate centres around how much or little spare capacity remains in the economy and, crucially how best to measure it.
“If the official unemployment rate continues to decline (6.2% in July) then it is likely that we will see some FOMC voters begin to call for a tightening of policy,” he says.
Given all of this speculation and the direction in which monetary policy in both the US and the UK is leaning, Iggo says, bond yields should rise.
Indeed, he argues, “The gap between yields and nominal GDP growth has widened over the summer and it would appear that the growth momentum in the US and UK would need to actually slow considerably to justify the current level of yield and push out interest rate expectations even further.”
The current data suggests this is unlikely to happen. But, he says, there remain a number of reasons not to expect yields to rise substantially soon.
First, Europe’s growth malaise could well hold back a large rise in yields in the US and UK. Second, yields are unlikely to rise significantly while the Federal Reserve and the BoE retain such large holdings in government bonds.
“As long as central banks retain these holdings and the argument is made that it is the stock of QE that is important and not the flow, then investors might continue to believe that there are downside risks to growth and inflation which will limit any rise in nominal yields,2 he says.
Adding: “Only when central banks start to discuss, in earnest, plans to reduce their asset holdings will we see a significant re-pricing of the bond market and that may be years ahead. In the meantime, there is plenty of scope for yields to rise to their end-2013 highs and that would deliver negative returns for government bonds over the remainder of 2014.”
And, he cautions, while the expectation is that yields will rise in the long term, there is no guarantee their will do so in a straight line.
“Those geopolitical issues that have hit investor sentiment in recent weeks have not been concluded. Ukraine and Russia are far from resolving their territorial disputes and the US has been dragged into military action again in a very unstable region. A deterioration in global security could impact on investor sentiment again quite easily and the long awaited improvement in global capital investment and trade flows could be delayed further.”
Caution is clearly still warranted within bond markets.
