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Bond markets took a beating in the wake of Donald Trump’s presidential election victory, as inflation-weary investors weighed the incoming administration’s growth policies. Massive fiscal spending and even bigger corporate and personal tax cuts all point to faster inflation in 2017 and beyond, which would force the US Federal Reserve to tighten monetary policy faster than previously expected.

Those concerns were partially justified at the Fed’s December 13-14 policy meeting, where officials voted to raise interest rates and signaled a faster pace of tightening over the next two years.[1] The central bank’s surprisingly hawkish press release suggested that policymakers were keeping a close eye on Donald Trump’s plan to revive the economy.

Investors should get clarity about the direction of fixed income in 2017. The European market will be particularly interesting, given the slower recovery and massive central bank stimulus. These forces shielded bonds from the rout that took place across the Atlantic.[2]

The European Central Bank (ECB) raised eyebrows in December by lowering its monthly bond purchases to €60 billion from €80 billion beginning in April. ECB President Mario Draghi tried to assure investors that the move wasn’t a taper, and that the ECB would continue to provide support so long as the Eurozone needed it.[3] The latest data suggest that the Eurozone will need all the support the ECB can provide. Gross domestic product (GDP) expanded just 0.3% in the third quarter, as Germany slowed and France showed little sign of picking up speed.[4]

Bond yields appear to be headed higher in 2017, although the impact will vary across countries. Rates in Germany will also continue moving away from their negative stretch. Based on a median estimate of economists polled by Bloomberg, European and US 10-year yields will climb through the first quarter of 2018.[5]

Italy is another source of concern for investors. The country’s banks are sitting on a mountain of bad debt that may trigger another financial crisis. Italy’s central bank recently announced that bailing out Banca Monte dei Pasci di Siena SpA, the country’s oldest lender, would cost €6.6 billion.[6]

Dismal economic growth, diverging monetary policies and a simmering debt crisis aren’t just impacting global bond markets. Stocks, equities and even commodities may also be impacted by these broad macroeconomic forces. The tail end of 2016 was very kind for US and European stocks, as the election of Trump fueled hopes of faster domestic economic growth. The year ahead may prove much more challenging since investors will demand tangible proof that Trump’s policies are boosting growth and profitability for US corporations.

The Federal Reserve’s surprisingly hawkish tone in its December policy decision also set the stage for growing divergence between the US dollar and other major currencies in 2017. The US dollar index, which tracks the performance of the greenback against a basket of six competitors, reached fresh 14-year highs at the end of 2016. The dollar’s strength also triggered a sharp selloff in gold and silver, nonyielding assets that normally track inversely with the greenback.

Gold prices plunged to 11-month lows in December, while silver futures hit their lowest since April.

The Fed expects to raise interest rates three times in 2017. Policymakers also foresee three additional hikes in 2018. A faster tightening schedule may impact everything from bonds to currencies, giving investors plenty of opportunities over the next 12 months.[7]

To keep track of all the latest developments in the financial markets, be sure to review the economic calendar daily.

[1] Sam Forgione (December 14, 2016). “Dollar surges after Fed raises rates, signals faster rate hike pace.” Reuters.

[2] Jennifer Ryan and Elaine He (December 23, 2016). “The I’s Have it For European Bonds.” Bloomberg Gadfly.

[3] Reuters (December 8, 2016). “ECB unexpectedly cuts asset buys to 60 billion euros per month from April.” Business Insider.

[4] Nathalie Thomas (October 31, 2016). “Eurozone GDP growth remains steady at 0.3%.” Financial Times.

[5] Jennifer Ryan and Elaine He (December 23, 2016). “The I’s Have it For European Bonds.” Bloomberg Gadfly.

[6] Lorenzo Totaro (December 30, 2016). “Paschi Rescue to Cost Italy 6.6 Billion Euros, Central Bank Syas.” Bloomberg.

[7] Harriet Torry (December 15, 2016). “Fed Raises Rates for First Time in 2016, Anticipates 3 Increases in 2017.” The Wall Street Journal.

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