Schroders: Are low interest rates a sign of secular stagnation?
Interest rates have fallen further with 21 central banks cutting policy rates this year whilst global liquidity continues to weigh on longer-term rates - an economic and strategy viewpoint.31.03.2015 | 09:22 Uhr
Financial repression has intensified since the start of the year with interest rates falling significantly around the world. At the latest count, 21 central banks have cut policy interest rates in 2015 and long-dated yields have fallen to unprecedented levels in the Eurozone. At the time of writing the German yield curve is negative in bonds up to seven years in maturity and JPMorgan estimates that $1.9 trillion (30%) of the euro area bond market is on a negative yield. The Eurozone has been the principal driver of the drop in G7 bond yields which are now below G7 core inflation for the first time in 20 years.
It is widely accepted that the driver has been the European Central Bank's (ECB) decision to start Quantitative Easing (QE) which has created a shortage of low risk assets in the region and put downward pressure on non-euro markets as investors have sought yield. We have already commented on these effects (most recently in the January Viewpoint) and attribute much of the recent fall in yields to QE, not just from the ECB but also the Bank of Japan (BoJ). Global liquidity continues to rise, even though the US Federal Reserve (Fed) brought its asset purchase programme to an end last year.However, there is a concern that the latest fall in interest rates is just another chapter in a long running saga of declining yields and that the underlying trend is being driven by secular stagnation. This occurs when an economy suffers from a chronic deficiency of demand such that it requires lower and lower interest rates to stimulate activity. It is an idea that has been around for many years, but was recently resurrected by Larry Summers, the former US Treasury Secretary.
The theory fits many of the facts as global growth has been disappointingly weak despite the fall in interest rates to record lows: some six years on since the recovery from the financial crisis began, it is remarkable that the Fed, Bank of England, ECB and BoJ all have interest rates at, or close to zero. Extraordinary policy stimulus has delivered less than ordinary results. Supporters of secular stagnation see the latest decline in rates as a continuation of a 30 year trend. If this is correct then any recovery will only be temporary and we will lapse back into weaker activity further down the road. Central banks will have to continue, or even restart QE and yields will trend even lower.