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Interest rates: The Race to the Bottom

May 21, 2020 By Mircea Vasiu

Investors around the world have a mandate – to search the highest yield with the lowest risk possible. Opportunities exist everywhere, as some markets outperform others, depending on a variety of economic, geopolitical, and other fundamental factors. Throughout history, one thing has remained consistent as the driver of risk, more precisely, the reason why investors shift their portfolio’s allocations from one asset to another. That is the interest rate level.

A study which compiled interest rates since the year 3000BC (both short- and long-term rates), reveals that after 2005, both short-term and long-term rates were close to zero. Which exceeds the levels seen during the 1930s during the  Great Depression levels. When only short-term rates fell, while long-term ones held steady between 2-4%.  Long-term investors were eventually rewarded and had a reason to be patient.

How about 2020?

2020 Global Policy Rate at or Below Zero

After the 2008 Global Financial Crisis, interest rates picked up a bit. While the Eurozone and Japan were mostly into the negative territory (especially after Draghi took over the ECB’s Presidency in 2011), other parts of the world offered high yields to investors (e.g., Australia, United States).

The Fed even hiked for a couple of years towards the end of 2018, feeling it had fulfilled its mandate of price stability and maximum employment. However, the first exogenous shock sent the policymakers on the race to the bottom. The question is – what is today’s zero level’s significance?

The chart above reveals that the global policy rate in April 2020 is well below the Post-Global Financial Crisis lows in 2008-2009. So where are investors going to look in the search for higher yields?

One obvious answer is the stock market. A Bank of America recent survey of global fund managers reveals that institutional investors are reluctant when it comes to the economic recovery. Moreover, the bullish/bearish sentiment shifts to the bearish bias, as only some of the managers surveyed still believe that this is a bull market.

And yet, Nasdaq is positive for the year, while the S&P500 and DJIA continue the recovery to the surprise of many. Moreover, all managers in the survey agreed that a rally is on the cards – a V-shaped recovery, a bull market, a bear market rally, a U- or W-shaped recovery. In other words, one way or the other, recovery takes place, eventually.

As the record low interest rates and the downward path are here to stay, investors have no other choice but to take the stock market risk. As for the premium, let that be the economic recovery everyone looks after.