Four reasons why rates will stay lower for longer
A September research note by Macquarie Bank supports what we’ve been thinking for a while: that interest rates are set to stay low well into the future. And if we are correct, it means this market – toppy as it seems – has further to run.
We recently published a blog post titled Three Reasons Why I am Still Bullish. It was our view that Calendar 2021 would begin strongly for equities and we currently believe that is the right posture for 2022.
First, fears generated by bubbles in some pockets of the market need to be balanced against the fact that these assets are not on the balance sheets of systemically important financial institutions and therefore their demise is unlikely to trigger a financial crisis. And while the market is expensive, we should not infer from bubbles in pockets that the entire market is a bubble.
Second, fears of a US treasury bond collapse need to be balanced against the fact that yields on US Treasuries remain much more attractive than those available from their contemporaries in Europe and Japan.
And finally, we need to balance the very present concerns about short end rate rises with the fact even if the US Federal Reserve raised rates four times, the real yield would still be negative, making equities the ‘go to’ destination for investors.
In an earlier article published in May we also highlighted the deflationary effect on wage growth from lower levels of unionised labour, and automation (technology) displacing jobs. These trends are structural rather than cyclical, suggesting consumer price inflation is unlikely to rise through wage growth. It should therefore come as no surprise that despite surging M1 Money Supply growth since before the 1980s, inflation has been stubbornly declining.
I mention these earlier posts because this week our thesis has been supported by research conducted by our neighbours here on Castlereagh Street, Macquarie Bank. In a 15 September research note What caught my eye? v.153 Why long-term rates must continue to fall? and perhaps reflecting on public comments made by their former boss Nicholas Moore, authors Victor Shvets and Terrence Leung make the observations repeated below.
Importantly, none of these arguments prevent a market correction, but they do support the idea of buying the dips, investing additional capital when markets fall and holding on for the long term.
“While investors are preoccupied with shorter-term questions of tapering and tightening, we have explored a longer-term topic of why rates have been on a consistently declining curve for the last three decades and why we believe that forces responsible for this phenomenon remain relevant and likely to strengthen. What are these forces?
- Financialisation is highly disinflationary and no longer reversable. On the contrary, it must continue intensifying, as any slowdown in liquidity or increase in rates or vols, can bring the entire house of cards down…Whether in 1987,1997, 2001, 2008 or 2020, societies refused to curb its expansion, and the best Central Banks could do was to manage it with as little damage as possible. Finance is already at least 5x larger than the real economy and it will continue to grow.
- Technology is also disinflationary and unstoppable, disintermediating corporates from their products and distribution as well as people from the fruits of their labour while lowering marginal cost of almost everything towards zero. The new phase (3rd generation tech) is likely to be more capital intensive, but it would be ultimately even more disinflationary.
- Inequality is unlikely to be corrected until much later in the evolution of technology and financialisation, at least a decade from now. Most studies indicate that inequalities depress demand and lower equilibrium rates, as wealth and assets continue to concentrate in the hands of the few with a low propensity to consume while the rest need ever lower rates to keep going.
- Demographic trends will continue deteriorating (except for the least developed economies), and while this implies higher consumption rate for certain groups, it will be more than offset by rising wealth concentration and slower growth rates. It is a ‘Catch 22’. The only thing that public policies can realistically aim for is to lower the intensity of disinflation by adopting three strategies. 1.Far greater and more consistent reliance on fiscal rather than monetary tools that re-direct capital from the ‘cloud of finance’ into areas from infrastructure and R&D to healthcare and education. 2.Make inroads into inequalities through re-working obsolete 19th century industrial age welfare and support policies while deploying aggressive wealth redistribution policies. 3.Cutting an umbilical cord between spending and borrowing by formalising an already close link between monetary and fiscal policies through MMT-style frame works. For some, these offsets could generate excessive inflation; however, for most nations, a return to 1970s-80s is not in the cards –there is just too much disinflation around and institutional pillars are sufficiently strong. But today’s fiscal policies are still structured as stop-and-go measures designed in response to shocks with policy makers preoccupied with sustainability and ways to return to some ‘mythical’ normality. In the 20th century, it took two world wars, depression and anti-trust strategies to exit the ‘gilded age’. On balance, it seems to us that low rates are likely to endure.”
And, of course, that is positive for equities.