For RBC Capital Markets, the differences between the US economy and other developed markets is one of the key themes to watch in 2015.
The US economy is expected to grow at a faster pace than many of its peers. Closely tied to this is the expectation that the Fed will continue to tighten monetary policy, thus loosening its grip on the economy as it raises interest rates sometime next year.
Meanwhile, central banks in Europe, Japan and China will double down on loose monetary policy to boost economic growth.
RBC’s Jordan Kotick and Jay Govender note that US economic data across the board is stronger today than in 1994, when the Fed was last started a hiking cycle.
However, concerns about weakness in other parts of the world is dampening investor confidence — and that might be giving investors a false sense of security regarding the pace at which the Fed raises rates.
“Given the fragility of the global recovery, the market currently prices in only a modest rate hiking cycle with a very low peak. We expect a hiking cycle that is earlier, faster, and peaks higher than the market is currently expecting. While the terminal rate is likely to be lower than in the past, we remain cognisant of the propensity for the Fed to overshoot the average of previous tightening cycles. We expect this to change going into the rate hiking cycle with a more aggressively priced US front end and belly of the curve being the outcome.”
Coming into this year, the Treasury market had priced in looser monetary policy, but bond prices continued to rally and yields continued to tumble as the Fed made it clearer that interest rates would stay low.
But as RBC notes, “The ongoing bid in US Treasuries is unlikely to withstand the fundamental backdrop of a tightening Fed and a resilient US economy. At present, the forward curve in the US is priced for aggressive flattening and structurally low rates.”
They add that in spite of this, the Fed will do its best to make its intentions clear so that it doesn’t shock markets.