Global economy going to the dogs
A more serious concern however, might be that low interest rates globally destroy financial business models that are critical to the functioning of modern day economies. Pension funds and insurance companies are perhaps the most important examples of financial sectors that are threatened by low to negative interest rates. Both sectors have always attempted to immunize their long term liabilities (retirement, health, morbidity) by investing at a similar duration with an attractive yield.
Now that negative and in almost all cases low short term rates are expected to persist, long-term bonds and similar duration assets do not offer the ability to pay claims 5, 10, 30 years into the future. With 10 year German Bonds at 30 basis points and the possibility of them going negative after the beginning of the ECB’s QE in March, what German, Dutch, or French insurance company would attempt to immunize liabilities at the zero bound or lower?
Immunization makes no economic or business sense at these levels; similarly for pension funds. In fact even households are handcuffed by low/negative yields, who everyday must now address their inability to save enough money at a high enough rate to pay for education, healthcare, and retirement obligations. Negative/zero bound interest rates may exacerbate, instead of stimulate low growth rates in all of these instances, by raising savings and deferring consumption.
This possibility may be one reason why the Fed appears to be moving to raise interest rates gradually beginning in June this year. In an attempt to elevate returns, investors and savers do all the wrong things required of a stable capitalistic model. Savers save more, not less, and invest at higher risk levels in order to reach their long-term liability expectations. Asset prices for stocks, high yield bonds and other supposed 5-10% returning investments become stretched and bubble sensitive; Debt accumulates instead of being paid off because rates are too low to pass up – corporate bond sales leading to stock buybacks being the best example. The financial system has become increasingly vulnerable only six years after its last collapse in 2009.
Investors and bondholders who have cheered every instance of lower and now sub-zero yields in developed countries because of near-term capital gains that accompany them, must now beware of the potential negative consequences going forward. Central banks have gone and continue to go too far in their misguided efforts to support future economic growth. “Home bred” monetary policies earn “blue ribbon” rewards in the short term, but in the long run may undermine the entire show and send the dogs towards the exits. Stay conservative in your investment portfolio. Own high quality bonds and low P/E, high quality stocks if you want to stay out of the doghouse.