The mantra for the last decade has been ‘low for long’. Is it possible that we could be looking at ‘Low For… ever?’
Here is some background on ‘Low for long’… It refers to low interest rates for a prolonged period. The benefit of low for long is the reduced cost of borrowing; not only for consumers and corporations, but also for the government. The cost to service US debt over the last decade has been dirt cheap. Over the last couple of years, the Federal Reserve Bank (FRB) has raised short term rates several times. This often creates fears that long term rates will follow suit, as they should. The concern is the increased servicing cost, its impact to cash flows, also the inverse relationship between rates and prices as an investor: As interest rates rise, bond prices fall.
To understand why we could be looking at prolonged low rates we should look at what causes rates to go up:
- A rise in inflation would lift long term interest rates
- Strengthening GDP typically leads to higher long-term rates
- Supply and Demand – As demand falls, so would prices. As a result, rates would rise to entice buyers.
This final scenario is the problem with the thought that long-term rates are on the rise. While the US is enjoying sustained growth, much of the developed world is actually struggling to sustain growth. We continue to see sovereign debt of developed countries yield well below the US:
- US 10 year: 2.87%
- Italy 10 year: 2.65%
- UK 10 year: 1.25%
- France 10 year: 0.66%
- Germany 10 year: 0.30%
- Japan 10 year: 0.03%
The recent slowdown in global growth should keep rates low, as these countries try to reignite their economies. The only country even remotely close to the US is Italy and that is due to political concerns and their banking system causing a crisis of faith.
The bottom line is an investor will buy a US Treasury for 2.87% over a German 10-year Bund for 0.30%. So, if long-term rates stay where they are, then we have another issue. We are only a few FRB hikes away from an inverted yield curve and a recession.
The FRB has a mandate to maintain full employment and clearly, a recession is not the best way to keep people employed. A more likely path forward is the FRB slowing their pace of hikes (allowing more growth in the US and abroad). In an effort to build their arsenal, they will likely focus on reducing their hefty balance sheet.
Your interest in our articles helps us reach more people. To show your appreciation for this post, please “like” the article on one of the links below:
FOR MORE INFORMATION:
If you would like to receive this weekly article and other timely information follow us, here.
Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment.
Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.