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Stewart RobertsonSenior Economist (UK and Europe)
Global shares suffered their first monthly decline in over a year as the prospect of looser US fiscal policy weighed on bond markets amid concern US interest rates will rise faster as inflation creeps up.
2 minute read
Key points
- Shares hit by rising US bond yields
- Markets fearful US fiscal stimulus could lead to overheating economy
- Investors reckon US rates could rise faster than previously envisaged
- Threat of trade wars adds to equity market jitters
Global equities endured a tumultuous February as worries over rising US interest rates helped bring a 15-month winning streak to an abrupt end.
The MSCI World index returned -3.49 per cent in local currencies, although that was the equivalent of a much more modest drop of 1.02 per cent in sterling terms as the pound fell against the majority of other currencies.
Among the leading markets, US shares were among the weakest following a sharp drop in the value of government bond prices as investors fretted that the country’s central bank would step up the pace of interest rate hikes as it looks to prevent inflationary pressures from building. The benchmark S&P 500 index returned -3.69 per cent in dollar terms.
US bond markets also fell with the closely watched yield on ten-year Treasuries surging to its highest level in more than four years. The US bond market is worried President Donald Trump is embarking on a huge fiscal stimulus at precisely the wrong moment.
The federal government deficit, having already increased 13 per cent to $666 billion in the accounting year to September 2017, is widely expected to balloon after lawmakers recently pushed through a series of spending increases hot on the heels of deep tax cuts enacted earlier in the year. The deficit looks set to virtually double to $1.2 trillion in the year to September 2019.
With fears the economy is close to overheating already prevalent, financial markets are concerned inflation might breach the US Federal Reserve’s target later this year. As a result, some reckon that could prompt the Fed, whose new chief Jerome Powell took up his post at the start of the month, to hike interest rates more aggressively than previously anticipated. The central bank is widely expected to lift benchmark interest rates at least three times over the course of this year, although some investors are now forecasting four or even five hikes.
The fact Trump is simultaneously threatening to spark a trade war is further undermining equities. In recent days he has said he intends to impose 25 per cent tariffs on steel imports and 10 per cent on aluminium as he looks to make good on his ‘America First’ agenda and his vows on the campaign trail to repatriate the jobs of rust-belt supporters.
The latest threat came just weeks after the US slapped tariffs of as much as 30 per cent on imported solar equipment and 50 per cent on washing machines, and follows Trump’s decision to pull out of the Trans-Pacific Partnership, his threat to scrap the North American Free Trade Agreement, and stall negotiations on the Transatlantic Trade and Investment Partnership.
It remains to be seen whether Trump’s bark is worse than his bite. After all there is a good chance Congress will wish to rein in his protectionist instincts. While his stance may play well with his core supporters, it ignores a wealth of evidence that such measures hurt everyone in the longer run. There is a clear risk he will incite retaliatory actions and a descent into a series of damaging trade wars, which would be damaging for both the world economy and equities.
