By Ranulf Glanville – July 7, 2016
Right now central banks around the world are taking unprecedented measures to keep interest rates pinned near zero. In fact, in many parts of the world interest rates are now negative!
We don’t see indications sharply higher interest rates are imminent. Still, we urge all readers to consider what could cause either short- or long-term interest rates to turn higher. Decisions involving debt need to consider not just the current situation, but also scenarios for what may lie ahead.
Below are a few things to think about when assuming interest rates will stay low for years and years.
1) Central banks ARE the bond market. In order to keep long-term interest rates low, major central banks have been on a bond-buying spree. Collectively as a group, central bank activity is now a dominant force in major bond markets. This dominant position creates a risk of instability if they ever want to scale back their bond purchases.
2) Politics can be poisonous. Although central banks are supposed to operate independently from government policies, the reality is that politics cannot be ignored. The current political flavour of the day is easy money. This could change. Recently we have seen major political upheaval in Europe due to Brexit. There are signs of stress on the banking system in China and Europe caused by distortions in the bond market, among other things. Current central bank policies may be to blame, or could become a scapegoat for these problems.
3) Low interest rates fuel excessive risk taking and speculation. Various studies have concluded that lots of the “free” money being made available by central banks is not going for productive purposes. Lots of it is flowing into the stock market, often using leveraged margin accounts. Some is going into hedge funds, which then place bets on commodities or other assets. Real estate speculation has made a comeback in certain US housing markets. Some Canadian housing markets look overheated. Land prices are rich, with some farm operations taking on lots of debt to expand. This may not matter much in the short-term, but it increases the odds of a crisis over time.
4) Market forces ALWAYS trump government policies, eventually. In free markets, the collective will of market participants WILL win out over the ideals imposed by government and central banks. These days traders and speculators are buying into the bond mania being peddled by central bankers. However, world economic conditions, the ebb and flow of money and geopolitical shifts cannot be fully controlled by any governmental entity. With various indicators from chart patterns to sentiment indicators suggesting bond markets are getting very frothy are we about to run out of buyers? Then what? What will happen to bond prices – and by extension interest rates down on the farm?
Summing up, today upward pressure on interest rates is low. We don’t expect this to change overnight but it’s time for readers to think about what could happen if central banks charge their policies either by choice or because they are forced to based on external forces.
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