Will rates move back up after the Covid-19 crisis? (Unlikely)
The current coronavirus pandemonium means attempts by central banks to normalise interest rates since 2008 have failed
London — Central bank interest rates are being cut once again to ward off a global financial shock, and the experience of the past 30 years suggests there is little chance rates will move back up once the crisis passes.
As the economic hit from the coronavirus pandemic unfolds, energy prices implode on a Saudi-Russia price war and global stock markets plummet; and G7 central banks are easing again to calm investors.
That means the attempt by central banks at normalisation of interest rates since the 2008 financial crisis has effectively failed. A spate of rate cuts in recent days shows a return to zero interest-rate policy across all G7 economies is now on the cards.
The scenarios under which key rates will be lifted when the virus passes look increasingly remote.
JPMorgan reckons that what it only recently saw as a “risk scenario” of the US joining Europe and Japan in the zero bond-yield club is now “much closer to reality”. Jan Loeys, a strategist at the bank, says the reasons Japanese and German government bond yields never recovered from their respective declines below 1% in 2012 and 2014, despite expanding economies, include “no inflation; low productivity growth; little fiscal expansion; and higher savings”.
“With the potential exception of fiscal policy, the other three conditions are in place in the US now, and are thus likely to keep US yields very low for some time,” Loeys says. He thinks that in the long term this should force investors to overweight equity: “80/20 makes more sense than 60/40.”
Bond markets, which reflect cost-of-money and inflation risk, support Loeys’s view. Ten-year US treasury yields plunged below 1% for the first time last week. Of the G7, only Italy now has a 10-year government borrowing rate above 1%, and three — Japan, Germany and France — are sub-zero. Only Italy has a 30-year rate above 2%.
Low rates have punished savers and pushed investors to take risks, while failing to drive growth and lift inflation in places such as Japan and Europe. Anthony Rayner at British fund manager Premier Miton says policymakers’ insistence on cosseting markets to prevent high borrowing rates have altered capitalism beyond recognition.
“Financial markets are not the provider of capital or a judge of economic and corporate health they once were: markets are managed by policymakers,” Rayner says.
Still, much is not known about the coronavirus, and some economists have said its impact could be temporary, making a case for policy support in the near term. US treasury secretary Steven Mnuchin said this week he is confident that a year from now the US economy will be in very good shape, pointing to an emergency rate cut by the US Fed and other policy measures the government is considering.
The secular decline in borrowing rates is the most durable mega-trend of the past 30 years. Inflation expectations have ebbed in ageing Western societies that are fueling a “savings glut”, as they near retirement and wage growth remains low.
In recent years, tightening cycles have been cut short before rates could scale previous highs. At 2.5% in this cycle, US Fed rates peaked in 2018 at less than half the pre-financial crash highs of 5.25%. That itself was a percentage point below the peak of 2000 — and almost half the now almost-unimaginable rates close to 10% in 1990.
For Britain, the flatlining has been more dramatic still, as the Bank of England only managed to get official rates as high as 0.75% in this cycle.
As short- and long-term borrowing rates wend their way ever lower, debt has piled up worldwide, compounding the sensitivity of financial markets, business and households to any retightening of monetary policy even after serial crises and shocks subside. That will keep the pressure on rates.
“To a large extent, financial markets now rule the economy more than the economy rules them,” reckons Didier Saint-George at French asset manager Carmignac.
• The opinions expressed are those of the author, a columnist for Reuters.
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