Lower for Longer
There was a time when ‘lower for longer’ meant that short term interest rates or official monetary policy in the developed economies, would remain low or perhaps go lower. That may still be the case but, except for the US, there is little scope for interest rate cuts from the major Central Banks (see below).
Country Official Interest Rate
Euro Area 0.00% Note the ECB deposit rate is – 0.40%
Japan – 0.10%
UK base rates are on hold and effectively frozen while Brexit drags on.
The US Federal Reserve recently lopped 0.25% off its Fed Funds rate although the futures market believes there will be a further 0.50% reduction before the end of year (87% probability of a 0.25% cut at the September 18th meeting and a 67% chance of another 0.25% cut at the October 30th meeting – Source: Investing.com as of 08/08/19)
The European Central Bank has stated that it will adopt further monetary easing should economic data deteriorate. Well it has, particularly in Germany where June’s industrial production, announced last week, was much worse than expected at minus 5.2% over the same month a year ago and pictured below (source: Trading Economics).
This week’s ZEW Economic Sentiment Index for August was also much worse than expected at minus 44.1 versus a consensus forecast of minus 28.5. You could be forgiven for thinking that bond markets are predicting Armageddon is around the corner as the entire German government bond yield curve is in negative territory out to 30 years. Yes, that’s right you can pay the German Government 0.18% to lend them money for thirty years!
Lend it to them for ten years and you’ll have to pay them 0.65%! Consider that inflation in the Eurozone is 1.7% as reported for July 2019, that’s a large negative real yield (ten-year bond yield less inflation) of over 2% – not good if you’re a saver.
For the record, ten-year UK government bonds or gilts yield 0.46% at the time of writing while UK inflation (CPI) is currently at 2.1% in the last report to July 2019.
Is it a Mad, Mad World?
You could be forgiven for thinking so. Lower for longer also seems to mean the longer you lend to your government, the lower the rate or yield you receive, compared to recent times. If you’re German, you will to lend them money for any period. Tough times but you can imagine mattress sales are doing well there.
The key factor for savers is to maintain or grow your wealth in relation to inflation. Earn less than inflation and you effectively erode the value of your savings.
The monetary backdrop should be positive for equities and particularly for quality companies. Bonds have effectively been commoditised; you hope to sell them at a higher price to someone else – sometimes referred to as the greater fool theory. We do not hold, nor could we justify holding, assets with a negative real yield, in our multi-asset Dynamic Fund whose investment objective is UK inflation plus 3% over rolling three-year periods.
Government bond yields have fallen in the US and Europe as each piece of negative economic data is released. They have fallen a long way but inflation hasn’t followed suit, tight labour markets and rising wages are a hindrance that needs to reverse. Time will tell but Government bond yields have a lot of bad news priced in. In Europe a reliance on a pushing-on-a-string monetary policy isn’t working. Europe needs a change of fiscal policy.
We have made few changes in August. In Dynamic, we have added to gold as an alternative currency. We also added to aluminium as we see the long-term case for that metal is still intact.
We hope you are enjoying the summer despite the indifferent weather this week, and as always, we greatly appreciate your continued support.
Lower for Longer