Resetting rate expectations

By BlackRock

Key points

  1. Central banks are retreating from super accommodative policies. We prefer stocks over bonds amid moderately rising rates.
  2. Markets priced in more gradual U.S. policy tightening after comments by the Federal Reserve chair and soft inflation data.
  3. The European Central Bank meets this week. Markets are also looking ahead to President Mario Draghi’s August speech.

Resetting rate expectations

Central banks increasingly are moving away from excessively easy monetary policy. Yields paused after recent gains last week, partly on soft inflation data. Yet we see them rising gradually, reinforcing the case for stocks over bonds.

Chart of the week
Difference between five- and two-year goverment bond yields, 2017

Chart of the week

Sources: BlackRock Investment Institute, with data from Thomson Reuters, July 2017.
Notes: The lines show the difference between benchmark nominal five- and two-year government bond yields for each country in percentage points. European Central Bank comments refers to Mario Draghi’s comments at the central bank’s annual policy forum on June 27 in Portugal.

Monetary tightening expectations shifted upward globally in June after markets interpreted ECB remarks as hawkish. This was reflected in a sharp rise in the gap between five- and two-year yields — a key gauge of monetary policy expectations. Germany led the move higher, as seen in the chart above.

The beginning of the end of ultra-easy
monetary policy

The major catalyst for the upward shift: ECB President Mario Draghi’s June comments on the need to normalize policy. Draghi said “a constant policy stance will become more accommodative,” as easy financial conditions accelerate economic activity. We see inflation in the eurozone eventually picking up amid ongoing monetary support, a sustained global economic expansion and an improving eurozone outlook. Accordingly, we see the ECB announcing in September that it will start scaling down its asset purchases beginning in 2018. We expect prudence and patience to guide the bank’s process for withdrawing monetary stimulus.

Elsewhere, the Fed appears committed to normalizing interest rates further and initiating its balance sheet reduction this year. Fed Chair Janet Yellen appeared to reinforce this stance last week in Congressional testimony that we view as consistent with past communications. Also, the Bank of Canada last week raised rates for the first time since 2010 and markets expect an October rate hike.

We believe gradual monetary policy normalization and sustained global economic expansion point to moderately higher global bond yields. This supports our preference for stocks over bonds and our favoring of the momentum and value style factors. A risk to our view: global policy normalization disrupts bond markets more than we expect and significantly higher bond yields undermine economic progress and equity valuations. We view this as unlikely.


  • Stocks rallied, led by emerging markets, after markets interpreted Fed Chair Yellen’s Congressional testimony as a sign normalization will be gradual.
  • U.S. Treasury yields fell and the U.S. dollar weakened after headline U.S. consumer inflation and retail sales missed expectations. Core inflation remained soft. Chinese inflation showed stabilization.
  • Major U.S. banks beat earnings and revenue expectations, which had been lowered on weak trading activity. President Trump tapped former Treasury official Randal K. Quarles to be the Fed’s top banking regulator.


  Date: Event
July 17 China GDP, industrial production, retail sales, urban investment; eurozone inflation
July 18 Germany ZEW Economic Sentiment Index
July 20 Eurozone consumer confidence, ECB press conference; Bank of Japan policy statement

Markets will focus on any shifts in the policy outlook from the ECB this week but don’t expect large changes. Draghi will present at the Fed’s Jackson Hole conference later in August, prompting speculation he will use that opportunity to signal a tapering announcement at the bank’s September meeting.

Managing Director, is Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active ...

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