Ultra-low interest rates are not going away

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All the signs are that negative central bank rates and ultra-low interest rates on risk-free savings are here to stay. Having been introduced as exceptional monetary policy measures, they are now the rule.

  • Ultra-low interest rates reflect an aenemic, disinflationary economic recovery, rooted in a chronic shortage of aggregate demand since the Global Financial Crisis. But more than this, they are the latest episode in a long-term trend toward lower real interest rates that began 40 years ago. Powerful disinflationary forces are at play. These could take just as long to reverse (if they reverse at all) and are at the beck and call of no central banker.
  • Welcome to the new world order – an environment where risk-free interest rates, underpinning valuations throughout the financial system, look set to remain at ultra-low levels at least over the medium term. The implications for investors and savers will likely be far-reaching.

Here are some of the consequences of ultra-low interest rates that should be on investors’ radars:

  • The law of diminishing returns is now setting in with monetary policy – the extent of the discussion within the ECB over the sense of the latest package of policy measures reveals the concern that possible negative consequences (e.g. damage to the health of financial intermediaries) may outweigh the benefits.
  • With little or no room to lower rates further, G3 central banks are now in no position to deal with recession. In the event of an economic downturn, fiscal policy in the form of government-sponsored stimulus programmes, tax cuts or even ‘helicopter money’, will be solicited. The good news is that thanks to ultra-low interest rates, the debt required to finance such programmes is more sustainable for sovereign borrowers.
  • Any asset whose supply is fixed will benefit from ultra-low interest rates as its future cash flows are discounted at a lower rate. Property markets, for example, in cities where it’s not possible to build, will rise in price. Think of  just about any European city and the only direction for property prices is up. Tensions arising from growing inequality and the gap between metropolitan elites and the provinces will only be exacerbated.
  • Bond investors have benefited from an extraordinary rally in prices that has generated exceptional gains. The Bloomberg Barclays Global Aggregate multi-sector bond index had returned over 6% this year. But the end of the road for rising bond prices is surely near and investors buying negative-yielding bonds on the basis that they will be able to sell them on at a profit are surely playing a mug’s game. Substituting bonds with equities providing a dividend income stream overlooks the volatility of equities.
  • The bottom line is that anyone saving for their retirement is going to have to either save more, retire later or face lower income in old age. We are all Japanese savers now…

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

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