{"id":10721,"date":"2023-10-02T20:00:00","date_gmt":"2023-10-03T00:00:00","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-asia\/insights\/has-the-era-of-zero-and-negative-interest-rates-ended"},"modified":"2023-11-01T11:14:17","modified_gmt":"2023-11-01T15:14:17","slug":"has-the-era-of-zero-and-negative-interest-rates-ended","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-asia\/insights\/has-the-era-of-zero-and-negative-interest-rates-ended","title":{"rendered":"Has the era of zero and negative interest rates ended?"},"content":{"rendered":" \t<div class=\"wp-block-rbcwm-well well is-style-is-style-b-blue-tint-4 b-blue-tint-4 mb-3 migrated\"> \t\t <h2 class=\"wp-block-heading has-text-align-left\" >Key points:<\/h2>   <ul class=\"list-spaced wp-block-list\"> <li> The theory of a \u201cneutral\u201d rate of interest for economies, one that neither boosts nor restricts economic activity, has long guided central bank policy. <\/li> <li> Neutral rates have been in a state of decline for decades, and while there are reasons to think they have moved higher as global economies change and adjust to a post-pandemic world, we continue to believe the longer-term drivers of lower interest rates will ultimately prevail. <\/li> <li> Rates are likely to remain at historically high levels for an extended stretch, but if and when central banks need to turn back to stimulus measures, low rates are likely to remain the primary tool in their toolkits. <\/li> <\/ul>  \t<\/div>      <!-- ******************* -->     <p>       The idea of a new normal in the aftermath of the Global Financial Crisis       15 years ago was a common theme amongst market participants. The Great       Moderation of the mid-1980s to 2007 was highlighted by long and sustained       economic expansions with stable inflation that could hardly have done less       to prepare investors for what was to follow.     <\/p>     <p>       Deleveraging by U.S. consumers following the housing bubble paired with an       anemic government fiscal policy response meant that monetary policy was       left to do the bulk of the heavy lifting as subpar economic growth gave       way to a stretch where too-low, rather than too-high, inflation was the       primary problem facing central banks. The net result was the first 0 percent       policy rate from the Federal Reserve and other global central banks, not       to mention negative policy rates later employed by others, on top of new       and alternative policy tools such as large-scale asset purchase programs.     <\/p>     <p>       Now it seems as though those issues have reversed. The U.S. fiscal       response to the pandemic went above and beyond, economic growth has been       persistently above long-term trend levels, and inflation is \u2013 of course \u2013 well       above target levels. As a result, the Fed has hiked rates to levels not       seen in over 20 years, with similar outcomes for most major global central       banks.     <\/p>     <p>       After a decade of investors navigating through zero and even       negative-interest-rate policy regimes, what might the next five, 10, and       15 years look like for central bank policy, and more importantly, have we       actually left the era of low interest rates behind?     <\/p>     <h2>The stars are the landmarks of the universe<\/h2>     <p>       \u201cAs is often the case, we are navigating by the stars under cloudy skies.\u201d       That was Fed Chair Jerome Powell in an August speech referring to the       stars that guide the Fed, and the uncertainty under which it is operating.       In Fed parlance, the \u201cstars\u201d policymakers are navigating by are the       natural rates of interest, or r* (pronounced r-star) and the natural rate       of unemployment, or u*.     <\/p>     <p>       And while perhaps rather poetic for a Fed chair, the theme of celestial       navigation is one he has discussed at numerous points during his tenure       and could give us an idea of what it means for the near-term policy       outlook and perhaps what lies beyond.     <\/p>     <p>       To be clear, these theoretical natural rates of interest and       unemployment \u2013 or the levels that should prevail at times of price stability       and full employment \u2013 are just that: theoretical. But there are numerous       models that attempt to estimate these celestial beings.     <\/p>     <p>       The first chart shows one of the most common models co-created by current       New York Fed President John Williams to estimate the prevailing real       natural interest rate, which is adjusted for inflation. This natural level       still sits at just 0.56 percent on a real basis, or 2.56 percent when adding the Fed\u2019s       2 percent inflation target.     <\/p>     <!-- ex 1 -->     <h3>       One estimate of the \u201cnatural\u201d interest rate suggests we\u2019re still in the       era of low rates     <\/h3>     <div class=\"row mb-4 migrated\">       <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">         <img decoding=\"async\" src=\"https:\/\/www.rbcwealthmanagement.com\/en-asia\/wp-content\/uploads\/sites\/8\/2023\/10\/has-era-zero-rates-ended-en-chart-1.png\" alt=\"Model estimate of the so-called \u201cnatural\u201d interest         rate quarterly from December 1973 through June 2023\" class=\"img-fluid mb-1-half\" \/>       <p         class=\"sr-only\"         id=\"chart1desc\"       >         The line chart shows a model estimate of the so-called \u201cnatural\u201d interest         rate quarterly from December 1973 through June 2023, and the rolling         10-year average since 1983. The natural interest rate declined sharply         after the global financial crisis in 2008; the 10-year rolling average         fell from roughly 3% in 2008 to less than 1% in 2019. The natural rate         currently remains far below its level before the financial crisis, with         the model estimate around 0.5%.       <\/p>       <ul class=\"rbc-legend rbc-legend-inline\">         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-dark-blue-tint-1\"><\/div>           Model estimate of &ldquo;natural&rdquo; interest rate         <\/li>         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line rbc-legend-dashed c-warm-yellow\"><\/div>           Rolling 10-year average         <\/li>       <\/ul>            <p class=\"footnote\">           Note: Model based on the Holston-Laubach-Williams estimate of the real           (inflation-adjusted) natural rate of interest.         <\/p>         <p class=\"disclaimer\">Source &#8211; RBC Wealth Management, Bloomberg<\/p>       <\/div>     <\/div>     <p>       Why might this be? Interest rates have been in a state of steady decline       since the Great Inflation of the 1970s and 1980s, while other research has       suggested interest rate levels have been in a steady state of decline over       the past 700 years. The key drivers of this so-called natural rate of       interest are rather simple, in our opinion. Global potential growth has       naturally slowed over time as economies have matured. The biggest driver,       demographics, remains firmly in favour of lower natural rates as the global       population ages, continuing to fuel excess savings and demand for what are       perceived to be safe assets. Risk aversion, particularly after the       economic and psychological harm of the financial crisis, is also perhaps       another factor anchoring natural interest rates lower.     <\/p>     <p>       But whether it\u2019s a 40- or 700-year trend, those are powerful forces to       contend with, suggesting that this current episode of historically high       policy rates in the U.S. and globally is perhaps more likely an aberration       rather than a break from the post-financial crisis era. In fact, Williams       has maintained at numerous points this year that he sees little reason to       think the natural rate of interest has moved higher.     <\/p>     <p>       That said, there may be some reasons to think that natural interest rates       could indeed begin to trend higher in the years ahead.     <\/p>     <h2>The Fed\u2019s North Star<\/h2>     <p>       There\u2019s one more star the Fed navigates by, but this one is easy to       observe and has remained constant for some time: the natural rate of       inflation, or \u03c0*, which has been formally 2 percent since 2012.     <\/p>     <p>       As the below chart shows, Fed policymakers also broadly agree with the       view that the longer-run natural interest rate is around 2.50 percent, a real       level of 0.50 percent plus the 2 percent inflation target, though at the margins this       has begun to shift higher with some at the Fed seeing it around 3.3 percent       following the Sept. 19\u201320 policy meeting.     <\/p>     <!-- ex 2 -->     <h3>       As markets price a higher natural rate, will the Fed projection follow?     <\/h3>     <div class=\"row mb-4 migrated\">       <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">         <img decoding=\"async\" src=\"https:\/\/www.rbcwealthmanagement.com\/en-asia\/wp-content\/uploads\/sites\/8\/2023\/10\/has-era-zero-rates-ended-en-chart-2.png\" alt=\"Market-based expectation of the longer-run U.S.         policy interest rate monthly from January 2007 through September 2023\" class=\"img-fluid mb-1-half\" \/>       <p         class=\"sr-only\"         id=\"chart2desc\"       >         The line chart shows the market-based expectation of the longer-run U.S.         policy interest rate monthly from January 2007 through September 2023, and         the Fed\u2019s quarterly median projection of the longer-run rate from January         2012 through June 2023. Two U.S. economic recessions are highlighted:         December 2007 through June 2009, and February 2020 through April 2020. The         Fed\u2019s estimate steadily declined from 2012 to 2019, and has remained         largely unchanged since 2019 at 2.5%. Although the Fed\u2019s estimate has         remained stable, the market-implied rate has risen from roughly 1.5% in         mid-2020 to roughly 4% today.       <\/p>       <ul class=\"rbc-legend\">         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-bar c-carbon-tint-1\"><\/div>           U.S. recessions         <\/li>         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-dark-blue-tint-1\"><\/div>           Market-based expectation of longer-run policy rate         <\/li>         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-warm-yellow\"><\/div>           Fed&#8217;s median projection of longer-run policy rate         <\/li>       <\/ul>         <p class=\"footnote\">           Note: Market-based expectations based on 5-year, 5-years-forward           Overnight Index Swap rate; Fed projection based on Federal Open Market           Committee target.         <\/p>         <p class=\"disclaimer\">Source &#8211; RBC Wealth Management, Bloomberg<\/p>       <\/div>     <\/div>     <p>       The market may also be entertaining the idea that natural rates could       shift higher as gauged by an index that captures what the market expects       overnight rates to average over five years, beginning five years from now.       It too has consistently trended lower since 2007 only to reverse to nearly       4 percent recently.     <\/p>     <p>       In our view, there are perhaps two key reasons why, and maybe one       ancillary one. The first likely stems from the strong policy response to       the pandemic that sparked a brisk recovery and an environment where       inflation is modestly more structural than it has been in some time.     <\/p>     <p>       The second relates to the Fed\u2019s North Star \u2013 the 2 percent inflation target. Powell       has also highlighted in recent years the challenge posed by low natural       rates, which is essentially that during economic downturns or times of       stress the Fed only has a small window between 2.5 percent and 0.0 percent within which       to cut rates in order to provide economic stimulus. After the effective       lower bound of 0.0 percent is reached, the Fed has to revert to other alternative       tools beyond the policy rate.     <\/p>     <p>       If real natural rates are indeed likely to remain historically low and       near 0.0 percent, then the only way to create a larger window to manage policy       rates is to raise the inflation target. This has been a regular point of       discussion in recent years, and though the Fed would never broach the       topic at a time when inflation remains entirely too high, we see a decent       chance the Fed could begin to publicly explore the idea as early as 2025.     <\/p>     <p>       Lastly, there\u2019s the issue of artificial intelligence (AI), though       admittedly it is a relative unknown as it relates to natural rates, that       could be an underlying longer-term dynamic that has investors reassessing       the future interest rate levels. But low productivity has long been a drag       on potential economic growth rates. Should AI deliver on its rosiest of       promises, then perhaps markets may be starting to price in the chance that       AI fuels a productivity boom and, therefore, higher potential growth,       though this is surely a longer-term issue.     <\/p>     <h2>The normal verdict<\/h2>     <p>       What does all of this mean for investors? Our base case is that the       long-term trend of lower rates will remain largely in place. On the issue       of a new normal, or a reversion to some old normal, we maintain a view       that there really is no normal. Monetary policy and central bank toolkits       will continue to evolve with each business cycle and perceived economic       era.     <\/p>     <p>       Within that framework then, it\u2019s likely the case that the current yield       environment presents a smorgasbord of opportunities for investors. As the       final chart shows, cash has had its day in the sun since the Fed began       raising rates in March 2022 delivering total returns of nearly 5 percent based on       1\u20133 month Treasury bills, while longer-dated treasuries are still down by       over 20 percent, one of the biggest performance gaps on record. But the tide may       already be shifting, as longer-dated bonds are already clawing back       returns with central banks appearing to be at or near peak rate levels.     <\/p>     <!-- ex 3 -->     <h3>The outperformance of cash may have run its course<\/h3>     <h4>Rolling 15-month total returns<\/h4>     <div class=\"row mb-4 migrated\">       <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">         <img decoding=\"async\" src=\"https:\/\/www.rbcwealthmanagement.com\/en-asia\/wp-content\/uploads\/sites\/8\/2023\/10\/has-era-zero-rates-ended-en-chart-3.png\" alt=\"Rolling 15-month total returns for long and intermediate Treasury bonds and cash\" class=\"img-fluid mb-1-half\" \/>       <p         class=\"sr-only\"         id=\"chart3desc\"       >         The line chart compares the rolling 15-month total returns for the         Bloomberg US Treasury Bills 1-3 Month Index, Bloomberg US Intermediate         Treasury (1-10 Year) Index, and Bloomberg US 10+ Year Treasury Bond Index         monthly from June 1993 through September 21, 2023. Cash and short Treasury         Bills have returned 4.8 percent since the Fed began raising rates in March 2022,         while intermediate Treasury notes are down 2.6 percent and long Treasury bonds         are down 26.7 percent. However, the chart shows that intermediate and long         Treasuries have outperformed cash more often than not over the past 30         years.       <\/p>       <ul class=\"rbc-legend rbc-legend-inline\">         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-dark-blue-tint-1\"><\/div>           Long Treasuries         <\/li>         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-tundra\"><\/div>           Intermediate Treasuries         <\/li>         <li class=\"rbc-legend-item\">           <div class=\"rbc-legend-line c-warm-yellow\"><\/div>           Cash         <\/li>       <\/ul>         <p class=\"footnote\">           Note: Cash represented by Bloomberg US Treasury Bills 1-3 Month Index,           intermediate Treasuries by Bloomberg US Intermediate Treasury (1-10           year) Index, long Treasuries by Bloomberg US 10+ Year Treasury Bond           Index.         <\/p>         <p class=\"disclaimer\">Source &#8211; RBC Wealth Management, Bloomberg<\/p>       <\/div>     <\/div>     <p>       But attempting to time the market is only likely to mean that an investor       will miss it altogether. So, we would simply employ a strategy in coming       months and quarters of gradually moving out of cash and short-dated bonds       in a higher for longer, but maybe not forever, rate environment.     <\/p>","protected":false},"excerpt":{"rendered":"<p>As global interest rates reach levels not seen in more than a decade, we explore what may be in store for the future of monetary policy.<\/p>\n","protected":false},"author":0,"featured_media":10726,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2023-10-03 00:00:00.0","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[42],"tags":[341,342],"rbcwm_content_owner":[],"rbcwm_need":[],"rbcwm_segment":[205,206],"rbcwm_solution":[],"rbcwm_topic":[212],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-10721","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","tag-negative-interest-rates","tag-zero-interest-rates","rbcwm_segment-business-owners-and-entrepreneurs","rbcwm_segment-individuals-and-families","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"As global interest rates reach levels not seen in more than a decade, we explore what may be in store for the future of monetary policy.","rbcwm_post_author":[92],"rbcwm_custom_breadcrumb_text":"","rbcwm_custom_breadcrumb_link_url":"","rbcwm_disclaimers":{"add_disclosures":["Yes"],"perspective_disclaimer":["No"],"expandable":[],"omit_from_pages":[],"disclaimer_footnote":""},"rbcwm_insight_cta_id":null,"rbcwm_pagination":{"next_link":"","next_link_text":"","previous_link":"","previous_link_text":""},"rbcwm_video_duration":"","article_time":"","rbcwm_enable_toc":false,"rbcwm_toc_selector":"h2"},"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v24.8 (Yoast SEO v26.8) - 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