Bond Market Observations

Crossing the Channel

  • The Fed is looking to cross the channel between central banks with low policy rates and those with high policy rates
  • An increase in Fed funds could strengthen the dollar relative to currencies where central banks are not tightening
  • Risks are skewed toward a slower Fed, leading to inflation pressures building in the U.S. and making TIPS attractive
  • If the Fed remains on hold for an extended period, other central banks may ease policy further, sending overseas investors into U.S. assets

In the wake of the Financial Crisis, central banks around the world have been adjusting monetary policy. At this stage, central bank policy rates have settled in a narrow ‘channel’. We think about this channel as being divided into two groups. At the lower end are countries with zero or slightly negative policy rates. These are represented by Japan, Switzerland and the Eurozone which are dealing with unwanted disinflation. At the upper end of the channel are countries with higher central bank policy rates. These are represented by Canada, Australia, New Zealand and large emerging market countries dealing with domestic inflation brought on by weaker currencies. In the middle of this channel, and trying to cross it, is the Federal Reserve as it looks to hike rates in 2016 and beyond. 

Download PDF for full article

Share This Page