The interest rate predicament
Interest rates are the primary tool in Central Banks toolkit to bounce back from recessions. As far back as the data goes, the US Fed has always lowered interest rates during recessions.
One of our managers recently said they believe Janet Yellen (Chair of the US FED) has the worst job in the world. Whilst this was a slight exaggeration, it does have some merit. The US Fed, along with Central Banks around the world, have a large predicament. Specifically, an interest rate predicament.
The theory being:
cheaper money = population borrow more = population spend more = stimulated economy
This theory was in full effect in the 2008 recession (GFC), where the US rates fell from over 5% to effectively 0%. And it worked to a large degree, the economy did bounce back. However, unlike previous recoveries, interest rates did not bounce back in the subsequent recovery.
So the best tool that Central Banks have to fight recessions is to lower interest rates. And interest rates are already at historic lows? Here lies the predicament.
Janet Yellen realises this, of course, and would like to raise interest rates but has been held back due to fragility of the global economy. The FED had its first interest rate increase in over 10 years back in December 2015 (0.00% to 0.25%). Despite many promises, we are yet to see another interest rate hike in 2016.
If another recession is around the corner, investors won’t be able to rely on interest rate cuts for another rescue.
7 November, 2016 – Dan Jenkins is NZAM’s Business Analyst.
This NZAM article is provided for general information purposes only and does not purport to give investment advice. This information is not intended for or directed towards retail investors but is for the use of researchers, financial advisers and wholesale clients. While the information contained in this document has been prepared with all reasonable care and has been sourced from published information believed to be reliable, accurate and complete at the time of preparation, its accuracy and completeness is not guaranteed. New Zealand Assets Management Ltd accepts no responsibility or liability for any errors or omissions or misstatements however caused. Information and any analysis, opinions or views contained herein reflect a judgement at the date of publication and are subject to change without notice. To the extent that any such information, analysis, opinions or views constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised advice under the Financial Advisers Act 2008, nor do they constitute advice of a legal, tax, accounting or other nature to any persons.