Over the last several years we have heard conflicting messages of ‘low for long’ and ‘upward pressure’ when it comes to interest rates.  There are valid cases for either, however to date, low for long has prevailed… Why?

Over the last several years it has been easy to look at rates and say, “how could they get any lower?” Then we get hit with a number issues that drive them even lower. It could be a geo-political concern that makes US Treasuries look desirable as a safe asset. Or perhaps a concern with the stock market that causes a flight to safety.

Interest Rates

Regardless of the cause things continue to hold long term interest rates in a historically low range. This could continue for some time as international markets are experiencing strong headwinds with inflation and unemployment, which make US Treasuries look desirable to foreign investors.  The rising dollar over foreign currencies also makes the Treasury attractive to foreign investors.

Even as the Federal Reserve Board (FRB) sets the stage for raising rates later this year, it is good to remember that these would be short term rates. The FRB can exercise direct control over short rates, however longer rates react more as a side effect as opposed to an act of direct control.

Corporate Profits

Something to consider regarding the global economies impact at home is the inter-dependency of multi-national corporations that derive profits from outside of our borders.  Currency movement over the last year contributes greatly to weaker than expected earnings. As the dollar moves north, profits from foreign currencies become less valuable.

Rate of Return Expectations

As we continue to have a more constant low for long environment this impacts all things including rate of return expectations. In a well-blended portfolio interest rates play a role in the performance that one can expect from an account. As rates remain low, the ability for interest bearing investments to augment performance as a hedge against equity volatility decreases.

Low Rates and GDP

As rate of return expectations may need to be adjusted, so must GDP expectations. Our credit based system of economic growth is heavily dependent upon credit spending for continued expansion.  The lower rates are, the less impactful credit creation is to economic expansion. Credit has the ability to exponentially expand wealth however the closer the exponent gets to one the less and less wealth is created. As overall rates remain low the incentive for credit spending and cash remaining invested decreases, making credit based system more anemic.

Inflation

Inflation or more accurately deflation has grabbed hold as oil prices have plummeted. Headline inflation has fallen across the globe. In the U.S., the core consumer price index (CPI), which excludes volatile fuel and food, remained almost unchanged at 1.6% for 2014, down from 1.7% the prior month. Headline CPI however was up only 0.8% for the year[1]. Internationally, Europe saw prices contract 0.2% in 2014, while the pace of inflation slowed in China as well.

In all the data last week was not encouraging regarding the current economic landscape. While Europe faces a battle with deflation and China battles keeping a head of steam in their conversion to a consumption based economy, The U.S. looks to be the bright spot on the global economic landscape, with moderating growth on tap for 2015. While inflation is moderating, lower unemployment and lower fuel expenses have created an increase in discretionary income, which is all important to an economy who derives approximately 70% of growth from consumption.

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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.

[1] www.investing.com – economic calendar