What’s normal? History suggests that there is no such thing as a permanent normal, though there are often extended periods where dominant trends remain broadly the same and then there are times where there is a material break from these trends. Economic and financial market history is no exception, though this doesn’t stop talk about whether/when interest rates will ‘return to normal’.
Take a look at the chart below, which plots the official bank rates in the US and the UK, along with their averages, over the last 60 years. The levels of rates give an insight into economic history, albeit pretty one dimensional. The first thing of note is that there are far more periods when rates have moved well away from their average than when they have been close and, secondly, that rates have rarely remained static for long, with the exception of the last 10 years (and even here, non-rate policy was of course getting much looser).
US and UK central bank rates over the long term
Source: Bloomberg, 31/03/1960 – 08/06/2018.
Averages are tempting to calculate but are often unhelpful in providing a context, though this is how they tend to be used. They are included in the chart above solely because there is such a focus on whether rates will return to ‘normal’. So, firstly, as outlined above, there is no normal, secondly, even if there were, averages would probably be a poor representation of normal and, thirdly, just to underline the futility around the concept of returning to normal in this case, debt levels globally are well above most previous points in history where the rate cycle is just starting out (if this is what this turns out to be).
So, wanting to assess the degree to which markets and policy have left a very unusual period behind is understandable, though focusing on rates relative to long term averages, and even pre-GFC levels, is probably more distracting than helpful. However, there are other more nuanced observations which are worth looking at.
Over recent months, the globally synchronised growth story has faded, and the US is now looking like the engine of global growth again, a characteristic which had dominated global economics for decades. Understandably, the US is raising rates in part-response to strong conditions domestically, though this has unintended consequences beyond its borders, a dynamic that emerging markets are only too familiar with.
Indeed, higher US rate rises (and a stronger US dollar) will have contributed to the recent spate of mini crises in emerging markets (Turkey, Brazil, Russia and Argentina). It’s not that there haven’t been financial crises since GFC, for example Greece in 2011, but they are becoming more frequent and are involving larger economies, even if they have been broadly ‘contained’.
In general, riskier assets are starting to behave in a more volatile manner, and traditional market dynamics more broadly are reasserting themselves, such as bonds and equities being more negatively correlated. In other words, there is a better working of the risk-on/risk-off dynamic which policy makers had sought to disrupt when there were concerns that investors would all go down the risk-off route.
How major central banks react to crises going forward will be crucial: will they continue to step back from markets, or revert to manipulation? A test case will be how the ECB responds in the face of Italian political developments, and no doubt EM crises will only drive a response if they materially threaten the interests of the major economies. In that sense, our view on US rate rises remains that they will be gradual but flexible.
In summary, a number of developments suggest that the exceptional post-GFC period is being left behind, though gauging the progress of this process by rates, certainly relative to their averages, is unhelpful. We think it sensible to assume that if we continue to get less manipulation by central banks, market dynamics will continue to reassert themselves, and this might well be considered more normal.
One of the implications is that fundamentals at a stock level and at a country level are becoming more relevant again: the ability to service debt jumps to mind, so zombies beware! We continue to retain good quality credit in corporate bonds and have a focus towards the major economy stock and bond markets.
The value of investments will fall as well as rise and investors may not get back the original amount invested.
Forecasts are not reliable indicators of future returns.
For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.
Source for information: Miton as at 13/06/2018 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
Miton has used all reasonable efforts to ensure the accuracy of the information contained in the communication, however some information and statistical data has been obtained from external sources. Whilst Miton believes these sources to be reliable, Miton cannot guarantee the reliability, completeness or accuracy of the content or provide a warrantee.
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