Ap
pril 2015
Schro
S
oderrs
Talk
T king
g Po
oint
Are
A lo
ow intterestt rate
es a sign
s
of
o sec
cular
stagna
s
ation
n?
Ke
eith Wade, C
Chief Econo
omist and Sttrategist
Fin
nancial repre
ession has inttensified sinc
ce the start o
of the year with interest ra
ates falling siignificantly around the wo
orld.
At the latest co
ount, 21 central banks have cut policyy interest rate
es in 2015 an
nd long-dateed yields have fallen to
unprecedented
d levels in the
e Eurozone.
It is
s widely acce
epted that th
he driver has been the Eu
uropean Cen
ntral Bank's (ECB) decisioon to start Quantitative
Ea
asing (QE), w
which has cre
eated a shorttage of low riisk assets in the region and
a put downnward pressu
ure on non-e
euro
ma
arkets as inve
estors have sought yield. The recent fall in yields can be attrib
buted to QE by both the ECB and the
e
Ba
ank of Japan (BoJ). Globa
al liquidity co
ontinues to ri se, even tho
ough the US Federal Resserve (Fed) brought
b
its assset
purchase progrramme to an
n end last yea
ar.
Ho
owever, there
e is a concerrn that the lattest fall in intterest rates is
s just anothe
er chapter in a long running saga of
declining yieldss and that the
e underlying trend is bein
ng driven by secular stag
gnation. This occurs when an econom
my
sufffers from a cchronic deficciency of dem
mand such th
hat it requires
s lower and lower interesst rates to stimulate activiity.
Th
he theory fitss many of the facts as global growth
h has been disappointin
d
gly weak deespite the fall in interest
rattes to record
d lows. Extra
aordinary po
olicy stimuluss has delive
ered less tha
an ordinary rresults. Supporters of
secular stagna
ation see the
e latest decline in rates as a continu
uation of a 30
3 year trendd. If this is co
orrect then any
a
covery will o
only be temp
porary and we
w will lapse
e back into weaker
w
activity further doown the road
d. Central
rec
banks will havve to continu
ue, or even restart
r
QE annd yields will trend even lower.
Re
ecent US datta has tended
d to support the stagnatio
on theory witth the economy experienncing a torrid first quarter of
2015. After a series of disappointing da
ata releases, current estim
mates sugge
est that the ecconomy grew
w by a mere
1.5
5% (annualissed) during th
he period.
On
ne-off effectss have played
d a role but an
a area of pe
ersistent wea
akness, which ties in withh the secular stagnation
hypothesis, hass been busin
ness investment. Orders ffor durable goods
g
are struggling to geet back to the
e levels reach
hed
prior to the fina
ancial crisis. Lack
L
of corpo
orate investm
ment is a sign
n that the cos
st of capital iss still too high despite po
olicy
rattes being close to zero. One
O of the tenets of secu lar stagnatio
on is that futu
ure investmennt returns are seen as po
oor
suc
ch that centrral banks can
nnot reduce the
t cost of ca
apital sufficie
ently to comp
pensate.
Wh
hilst there is evidence forr secular stag
gnation we w
would still see
e it as being too pessimisstic. It was always the ca
ase
tha
at the shock to the bankin
ng system would take tim
me to be overrcome as the
e private sect
ctor went thro
ough a period
d of
balance sheet repair. QE has helped sp
peed that pro
ocess by kee
eping interest rates low, tthus easing the
t burden off
debt, and drivin
ng up asset prices,
p
so im
mproving bala
ance sheets.
The process is quite well ad
dvanced in th
he US and to
o some exten
nt the UK, bu
ut is only justt getting goin
ng in the
Eu
urozone. Cruccially, the US
S and UK rec
capitalised th
heir banks att an early sta
age of the crissis, but the Eurozone
E
has
tak
ken much lon
nger. Last ye
ear's Asset Quality
Q
Review
w and stress
s tests brought this to a hhead and afte
er a period of
rec
capitalisation
n and retrencchment there
e are now sig
gns that bank
ks are beginn
ning to lend aagain. At the
e very least, this
t
wo
ould remove a considerab
ble headwind
d on Eurozon
ne activity an
nd should now provide suupport to the recovery.
Fro
om this persp
pective, we would
w
see the world econ
nomy in a pe
eriod of balan
nce sheet adj
djustment with countries
em
merging at diffferent rates from the ban
nking crisis. R
Rather than a chronic lac
ck of investm
ment opportunities, the drag
fro
om balance ssheet adjustm
ment means that it takes more time fo
or those oppo
ortunities to bbe realised.
SchrodersTalking Point
Page 2
This suggests that the weakness of growth in the world economy is still a consequence of the crisis –recoveries from
financial crises take considerably longer than those in a normal cycle. Consequently, we continue to forecast
recovery in the developed world this year with the US picking up in the second quarter and growth in Europe and
Japan improving. Admittedly though, at present it is difficult to distinguish this from a world suffering from secular
stagnation, a factor that will weigh on long rates.
Forecast update: pushing out Fed rate rise
Following the FOMC meeting which concluded on March 18th, we have pushed out our forecast for the first rate rise
until September 2015. Although the committee changed its language and opened the door to a June move, it also
cut its forecasts for growth, inflation and interest rates.
The factor which has swung the view has been the strength of the US dollar, which has exceeded even our bullish
expectations. This may be one reason for the weakness of durable goods orders in the US as the currency hits
profitability. More importantly from the Fed's perspective is that dollar strength is beginning to depress core inflation
through lower import prices. Although the Fed appears to be looking through the energy driven decline in headline
CPI, it will take account of a lower core rate which is running at 1.7%, a tad below the 2% which it would prefer.
Effectively the dollar has tightened financial conditions for the Fed.
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