Are interest rates about to plateau or peak? 

Investors on both sides of the big pond are speculating whether the central banks have now reached the end of their interest rates hikes - especially in the U.S. The ECB and the Federal Reserve raised the benchmark again in July to 4.25% and between 5.25-5.5%, respectively. Federal Reserve officials left it open whether the benchmark rate would be raised again in September at their last meeting in July. The board wants to continue observing the data over the summer, it said. In June, consumer price inflation stood at 3.2% year-over-year, which is still above the two per cent target rate.   

Dr. Ulrich Kaffarnik explains what the latest developments, e.g. the inverted yield curve, mean for investors. 

Have we now reached an interest rate plateau or a peak?  

The last rate hike didn’t push the yield of longer dated U.S. treasuries to new highs. As a result, the market is probably not expecting any further hikes. However, the Federal Reserve will be guided by inflation, which could rise again in the coming months. Recently, the U.S. Treasury has issued bonds with shorter dated maturities, which suggests that it expects lower interest rates longer term. I think the yield on 10-year U.S. government bonds is likely to move sideways in the near term.

What is more attractive at the moment: bonds or equities in the U.S.?

Generally, this always depends on the individual investor’s goals and desired risk level and there are also big differences between individual shares and bonds. The stock markets have recently benefited from the latest developments in artificial intelligence. However, purely from a valuation perspective and broadly speaking investors are not getting a risk premium for equities in the U.S. market. In comparison, U.S. treasuries and corporate bonds, which pay up to 5.5% interest in some cases, are therefore more attractive.  

Is TINA  (there is no alternative to equities) still valid? 

The interest rates hikes have changed everything, so I would say there are lots of alternatives to stocks and shares at the moment. At DJE, for example, we now also buy a lot of corporate bonds. We are gradually moving towards investing in longer-dated maturities for government bonds and investment-grade corporate bonds. In high-yield bonds, we remain cautious and invest in shorter dated maturities. 

What is the outlook for inflation? Will it stay at around 3% in the U.S.? And will central banks abandon their 2 percent target?

I don't expect us to return to inflation levels between 0% and 2% in the medium term. I think between 3% and 4% is more realistic.  But I also don’t believe we will see inflation rates of 7%, as was the case in the 1970s, for example. The 3% inflation mark was reached earlier than expected in the U.S., but I believe it may rise again this year. Oil prices have risen recently, and there may be further wage increases in the labour market. However, I don’t expect central banks to abandon their 2 percent target because of this. Market participants generally also don’t expect inflation rates to remain high in the long run as central banks will fight back.

Are credit spreads, i.e. risk premiums for high-yield or investment-grade bonds, too low?

Historically speaking the spreads are rather low. The market is currently pricing in a so-called soft landing - that is, a weakening of the economy without a recession. U.S. President Biden probably wants to avoid a hard landing (a recession) in view of the upcoming presidential election campaign. 

The inverted yield curve signals an impending recession.  Do you still expect we will enter one? When will the correlation normalise again?

It would be the first time that an inverted yield curve is not followed by a recession. We therefore expected more weakness in the economy earlier in the year. If we do enter a recession, the correlation would normalise again with the yield on shorter-dated maturities being lower that on longer-dated maturities.

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