What Janet Yellen’s testimony and US interest rates mean for global investors

23rd February 2015

Investors globally can expect US Federal Reserve Chairwoman Janet Yellen’s testimony to Congress on Tuesday and Wednesday to move equities, fixed income and commodities markets. David Stubbs, global market strategist at JP Morgan Asset Management explains why…

Investors will continue to seek definitive signs for when the US Fed will move to raise interest rates. A key consideration for Yellen is the health and strength of the US labour market and the implications that has for inflation.

Overall the jobs market has improved but uncertainty remains. In particular, Yellen will be watching the unit labour costs as a key determinant for underlying inflation pressures.

She will be looking not just at the quantity of US jobs growth but also at the quality of jobs being created, which has arguably be sub-optimal. She will also be looking at the long-term participation of various cohorts of the US jobs market to determine tightness or slack in the labour market.

Investors should listen for how Yellen is measuring inflation and the impact of currency movements. The current strength of the US dollar will make it hard for the Fed to tighten unless they are completely sure of the strength of the underlying economy.

A critical determinant for the strength of corporate profits going forward will be consumption.  Total private sector wage growth has recovered somewhat while corporate profit margins have taken a hit from the rising US dollar, the fall in energy prices and some growth in the cost of employing their labour force. If consumers and workers spend rather than save, this should help growth the economy and ultimately drive top-line earnings growth, making the Fed more likely to push ahead with interest rate increases.

Overall, it is likely that Yellen won’t want to disturb expectations among many Fed watchers that a first rate hike will occur over the summer and possibly in mid-June.  To the extent that this testimony is seen as less dovish than the Fed minutes released last week, it may put some further upward pressure on long-term interest rates both in the US and overseas.

By contrast, given the general steady improvement in economic conditions and the reduction in uncertainty implied by de-escalating tensions, the investment environment should still be relatively favorable for both US and global equities, even with the prospect of somewhat higher interest rates in the months ahead.

The big picture for US equities is that they can go up on a multi-year view, but investors should be realistic about returns at these levels, which are likely to be mid-single digit total returns at best.

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